A mutual fund is perhaps the first thing to come to mind for considerable passive earnings while investing in the market. However, there’s a choice to make between active and index funds before parting with your savings.
Herein, it’s important to note that all types of mutual funds are risky in varying degrees. Nonetheless, the primary contrast in active mutual funds vs index funds lies in their management style, investment objective, and cost.
Following is a look at what each of these fund types entails and an analysis of their differences.
What are Active Mutual Funds?
An active mutual fund is a popular instrument that pools investments from numerous individuals to invest in various securities. These include stocks, bonds, cash and cash derivatives, among others. A manager or their team decides how the fund’s money will be invested in an actively managed mutual fund.
What are Index Mutual Funds?
An index mutual fund is a type of passive fund, which tracks popular benchmark indices such as Nifty 50 and Sensex to generate near-identical returns. They are passive because no manager decides the allocation of the fund, but the index fund invests in its underlying index’s units in the exact same proportions to produce similar returns.
Mutual Funds Vs Index Funds – Key Differences
Fund allocation and management
The most significant difference between an index fund and a mutual fund is their investment and management style. In the case of mutual funds, dedicated fund managers handpick assets based on market trends. They also decide fund allocation accordingly. Therefore, the performance of these funds relies entirely on a fund manager’s knowledge and expertise.
Conversely, index mutual funds track renowned indices such as Nifty 50 and allocate funds to the constituent units in identical proportions. Since these funds replicate the properties of their underlying benchmarks, they do not require active management.
Fees and charges
One of the primary aspects that investors need to consider before choosing a fund scheme is its cost. The primary constituent of these charges is the expense ratio. It is the annual operating fee AMCs charge for portfolio management.
As the name suggests, actively managed funds require continuous and profound industry analysis on a fund manager’s part. After that, they pick suitable assets for fund allocation to ensure maximum returns. As a result, investors need to pay higher portfolio management fees.
On the other hand, index funds involve negligible involvement of a fund manager and, hence, comes with lower expense ratios.
Investors can run performance checks on both active mutual funds and index mutual funds to choose one depending on their financial goals.
The primary aim of actively managed mutual funds is to beat the market performance. This is why active funds tend to outperform in a bearish market most of the time. However, large-cap funds have underperformed the index since 2018.
On the other hand, passive funds have beaten indices they’re tracking over 80% of the time based on 5-year returns since 2018, according to Prime Investor. Index funds have also been more efficient in minimising losses when markets are underperforming to deliver better returns than large-cap funds.
Accordingly, investing in passive mutual funds such as the Navi Nifty 50 Index Fund might offer higher returns than most actively managed mutual funds.
Market volatility affects all mutual funds, notwithstanding the type. In this aspect, the only difference in a mutual fund vs index mutual fund is the risk type.
Risk in actively managed mutual funds revolves around the market capitalisation of companies. Small and medium cap funds, for instance, involve aggressive investment strategies and are more volatile than large-cap funds.
Whereas, index funds are risky because of tracking errors, leading to returns different from their underlying index.
Investment Tips to Take Note of
If you are new to mutual fund investments and are confused about which option to choose, here are a few pro tips –
- To begin with, examine your financial goals, risk appetite, and preferred investment timeframe to pick a fund scheme aligning with these requirements.
- Effective active fund investments demand detailed market understanding and continuous involvement of an investor. Therefore, individuals seeking a hassle-free investment plan can benefit better from index mutual funds.
- For effective risk management, investors can consider a balanced mix of market-beating and market-average returns by combining active and index mutual fund investments.
- Expense ratios may differ across AMCs. Compare multiple schemes before choosing the most suitable one. To avail of the lowest of investment costs, navigate to https://www.navimutualfund.com/. Enhance your net returns with the most affordable operating expenses.
Taking the above points into consideration can help in effective comparison before investing. Potential investors must ensure their choice aligns with their financial goals to ensure adequate returns.
Frequently Asked Questions
How does Navi calculate the expense ratios of mutual funds?
Similar to other AMCs, Navi calculates the expense ratio as a percentage of the total expenses against the total sum of the average annual AUM. You can refer to our article on what is expense ratio to understand the calculation and its impact on mutual funds.
Do index funds offer better returns than active mutual funds?
Index funds have a historical record of outperforming actively managed mutual funds. However, this should not be the sole factor influencing your choice while comparing index funds vs mutual funds, as some expert fund managers can assure you substantial returns against actively managed mutual funds.
Is an index fund more suitable for first-time investors?
Individuals new to mutual fund investments can achieve better risk mitigation with index funds as they take high performing benchmarks such as Nifty 50 as their investment framework, replicating the index’s performance. On the other hand, active mutual funds require greater involvement and understanding of market trends on the investor’s part.
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