Investors who are new to investing and do not want to spend time studying the stock market are considering mutual funds created by various asset management companies. Within mutual funds there are two major categories – active and passive funds.
Let’s understand what passive funds are and their benefits are:
What is a passive fund?
Passive fund is a type of fund that tracks a market index such as Nifty, Sensex and replicates the index composition of shares into the portfolio. The fund manager does not determine what stocks will be in the portfolio which makes them cheaper. Passive investment doesn’t try to beat the market but tries to mirror it.
Passive funds are not just good for investors who know nothing but also for investors who do not want to research various funds and assess the best one. Passive investing broadly is a buy-and-hold strategy for long-term investment horizons, with minimal trading in the market.
What are the different types of Passive funds?
Passive funds are primarily of two types:
- Index funds: Index funds are open ended mutual funds dependent on the performance of a particular index. Investors can buy and sell units at the net-asset values of the fund.
- Exchange traded funds (ETFs): They are listed on the stock exchange and customers can buy and sell at the real time prices through their trading accounts
What are the different benefits of Passive funds?
- Ultra-low fees: There’s no analyst constantly buying and selling stocks. Passive funds follow the index they use as their benchmark. Hence, their expense ratio is the lowest among the different types of mutual funds and is usually around 0.5%.
- Transparency: It’s always clear which assets are included in an index fund.
- Tax efficiency: Their buy-and-hold strategy doesn’t typically result in a massive capital gains tax for the year
- Simplicity: As the fun tracks an index, or group of indices it is far easier to comprehend than a dynamic strategy that requires constant research and monitoring of individual managers/investment themes
You can find out more about index funds here
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