What are Passive Funds & How They are Different from Active Funds?

Investors today have a variety of investment options to choose from. Generally, if you are a newbie in the investment sector and want to invest without studying the stock market, you may consider investing in mutual fund schemes. In mutual funds, there are two major subcategories- active funds and passive funds.

Let’s take a look at passive funds and also let us understand how different they are from active funds. But first, let us understand these two terminologies:

Active funds

The primary job of an active fund manager is to brainstorm and pick profitable investments, intending to execute a stock that outperforms the fund’s specified benchmark or index. Actively managed funds generally charge relatively high fees, because together with analysts and researchers, fund managers actively buy, hold and sell stocks to achieve maximum returns. Any fund which is actively managed by a fund manager is known as an active fund. The fund manager actively takes decisions on how to invest a fund’s capital and does the trading of stocks.

Passive Funds

A passive fund is a type of fund that religiously tracks a market index to allow a fund to fetch maximum gains. The fund manager does not actively choose what stocks the fund will be comprised of, which is the case in an active fund. This usually makes passive funds easier to invest in than active funds. Also, index funds are a good way for a ‘know-nothing’ investor because you do not need to research and know about the best performing fund.

Difference between passive funds and active funds

As mentioned earlier, passive funds do not involve the active participation of a fund manager. Hence their fee is far less as compared to that charged by an actively managed fund. The reason for passive funds to gain popularity among investors in India recently is their low expense ratio. The involvement of a fund manager in an index fund is comparatively less. That’s because index funds mimic the indices. One major reason where active and passive funds have huge differences in their expense ratio.

In actively managed funds, financial managers have to do a lot of industry research and accordingly move funds in various securities based on market performance. That makes active management costlier as there is a lot of research and other work put in towards the investment. But this isn’t the case with passive funds and that’s what makes them less expensive.

We hope this article helped you understand the difference between an active fund and a passive fund. Depending on your financial goals, choose the right mutual fund for yourself and always make sure to have a diversified financial portfolio.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.