Passive Funds: What are Passive Mutual Funds, Types & How to Invest

Passive mutual funds are exchange traded funds and funds that invest in index, thereby ensuring stable returns without much risk over the long term. Here’s all you need to know about these funds

What should be the investment strategy for passive funds?

Usually, passive mutual funds involve a buy and hold strategy, thereby minimising the costs associated with active funds, where the fund manager keeps juggling the portfolio depending on the market conditions to ensure a high rate of return. There are several investment strategies used by passive funds, including investing in index funds or exchange traded funds.

Market Alignment, returns rate and risk:

Unlike active funds, where the fund manager aims to beat the market, passive funds are usually aligned with the market, because they invest in market indices like the Nifty or Sensex. This means all the stocks in these indices will find representation in a similar ratio in their investment portfolio. These indexes usually mirror the market, and thus don’t deliver returns higher than markets. But the risks are much lower too, and because most passive fund investments are long term, the returns are compounded over time.

Cautious Investment:

Unlike active funds where the fund manager is constantly monitoring the performance of funds, passive mutual funds involve cautious, premeditated investments, which require very little monitoring. As such, you don’t end up panicking and selling funds when the market fluctuates. These funds are not biased towards any particular stock or sector and are more diversified as compared to active funds.

Low fees:

Apart from low fees, passive funds are usually transparent because they are aligned with an index, which can easily be monitored to see the specific assets involved. Also, because you are not buying and selling regularly, there are no major tax implications each year. However, it has also been argued that by locking investments into a specific fund based on an index, your ability to gain from short term fluctuations are limited. And since the holdings mirror the market, these funds rarely beat the market returns. You make a large profit only if the market booms exponentially. Active funds, on the other hand, are geared to constantly beat the market, albeit with much greater risk exposure.

Essentially, active investing where a fund manager aims to beat the market offers better returns, but at a higher risk. Passive investing is where one buys and holds index funds or other ETFs for a long term, where the wealth is built incrementally as the market grows. Open your trading account to begin investing in either or both today.