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    Aditya Birla Sun Life AMC Limited

    Active Funds or Passive Funds? Why not Both!

    Apr 04, 2022
    4 min
    4 Rating

    Here’s something to think about: Is your left hand superior to your right hand? Which of your two eyes do you like better – the left or the right? What about your ears? Do you prefer your brain over your heart?

    Difficult, almost impossible to answer, isn’t it?

    Of course one would never like to choose one eye or hand over the other. How could anybody live without either heart or brain? Both are equally important – and both work together, in perfect synchronisation, to keep you alive and alert.

    The same holds true for investing in mutual funds.

    Also Read - How to Invest in Mutual Fund?

    The Usual Debate - Active or Passive:

    The “Active Mutual Funds vs Passive Mutual Funds” fight has been going on for years now. However, the very premise on which this debate is based is faulty – how can lemons be compared to apples?

    Both active and passive funds have their pluses and minuses. Active mutual funds, actively managed by experienced fund managers, aim to outperform the market and earn you higher profits. But remember, in investing, higher rewards also entail higher risks.

    Passive mutual funds, on the other hand, mirror the market indices and cost less due to the absence of manager fees. This also implies that they never get the opportunity to outperform the market and earn hefty profits.

    So then which one is better? It all depends on 2 things:

    1. Your style as an investor: Every investor has his or her own investing ethics and rules. While some believe in being aggressive and reaping rewards from their investments, others follow a more conservative approach. Identifying your investing style has a big impact on the kind of fund you favour.

    2. Your risk-reward profile: Apart from your inherent investing style, your current situation in life in terms of money matters and financial goals also plays a big part in determining what kind of fund you prefer. Those with a larger risk appetite usually go for active funds, while investors with limited risk-taking capacity like to play it comparatively safer with passive funds.

    Although this may be the common classification, it is quite myopic in its view of the entire subject. Why not have the best of both worlds?

    The Balancing Act of Funds:

    An ideal portfolio is one which gives the investor a good balance of stability and growth. Thus, having a balanced mix of passive and active funds could be the solution you are looking for.

    For those starting out on their investment journey, passive mutual funds are a great stepping stone. They are less risky and cheaper compared to active funds. In recent years, passive funds and Exchange Traded Funds (ETFs) have gained much popularity thanks to the good performance of the Indian market. Such funds use the collective wisdom of the market to chart out investments. While this reduces the risk of fund manager bias, it also takes away the opportunity to outperform the market.

    At the same time, having some well-picked active funds in your portfolio is also a great strategy. After all, the whole point of investing is to make your money grow. Therefore, assessing your risk profile and choosing active funds accordingly could help you earn higher returns. Some background research will help you choose better since relying only on past performances is not the right way to go about it.

    Can active and passive mutual funds really co-exist?

    Just like the heart and the brain, the so-called “conservative” passive funds and “aggressive” active funds can actually work well together to make a wholesome portfolio. There is no hard and fast rule that you can have only one investing approach. You can always diversify your portfolio with different investing styles. Even if you are a risk averse investor who prefers passive investing, you can invest a small portion, maybe 10% of your portfolio, in active funds. Similarly, if you are an aggressive investor, you can mitigate your portfolio risk with a touch of passive investing.

    It is good to have both active and passive mutual funds. This gives your portfolio the flexibility to adjust to the changing market situations. You can determine the amount you want to allocate to active and passive funds, depending on your risk profile and investing timeline. A 30:70 or 20:80 ratio might work for conservative investors, whereas a 60:40 or 70:30 ratio might work for aggressive investors.

    Both active and passive funds can co-exist in a single portfolio -it’s all about finding the right equilibrium.

    Sources:

    https://economictimes.indiatimes.com/wealth/invest/active-vs-passive-mutual-fund-investing-which-ones-for-you/articleshow/80598202.cms

    https://www.crisil.com/en/home/our-analysis/views-and-commentaries/2021/12/active-and-passive-funds-can-coexist.html

    https://www.moneycontrol.com/news/business/personal-finance/how-to-maintain-a-healthy-mix-of-active-and-passive-mutual-funds-in-your-portfolio-7861221.html

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