Active vs passive mutual fund: Check out what is right for you

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Investors can invest in mutual funds in two ways — active and passive mutual funds. There has been an open debate on which one of the two is better. However, if we take into account the last three years, passive funds do seem to have performed well. The assets under management (AUM) of passive funds have seen an increase of 108% in the last year. There has been a steady rise in the total amount invested from Rs 1,48,038 crore in March 2020 to Rs 3,07,886 crore in May 2021. Kirtan A Shah, founder, and CEO, SRE Wealth in an exclusive chat with Money9’s Priyanka Sambhav said that whenever the market faces a downturn, investors in passive funds gain profit.

What are active and passive funds?

The actively managed fund are the ones wherein a manager of the fund house will decide at what time and in which options or in which stocks to invest the money in active funds. Fund managers shape these funds based on extensive research from market trends and benchmark indices. Actively managed funds attract higher charges which are called the expense ratio. Passive funds are passively managed. These funds work on the basis of a chosen benchmark index. These funds directly map the movement of the index. Due to a lack of active management, the cost of the passive funds remains low. Indexes and ETFs are passive funds.

When to choose passive fund?

In 2018, SEBI changed the category of mutual funds and the size of capping. This also changed the definition of large, small, and midcap stocks. According to Kirtan Shah, this became the turning point for the passive fund as the active fund manager had to bring in new changes in share selection. Shah says, ” If you want to invest in large caps only, then choose passive funds and if you want to invest in the category of small, mid or Flexi caps, then you can choose active funds.”

Passive investing comes is a better option whenever the markets are at lower levels. That’s why the performance of the passive fund was good in 2020.

What should you check in passive funds?

1) Every investor should first check their risk profile.

2) Track the difference between the returns from the index and the returns from the fund. The lower the tracking difference, the better.

3) Compare the expense ratio. Even if there is a lower expense ratio in passive funds, one has to pay brokerage charges in passive funds like ETFs.