Investing is always a tricky subject especially when new trends keep popping up. Index funds and exchange-traded funds (ETFs) are gaining attention as the future of investment.
Many believe they offer a smarter and simpler way to grow wealth. But is that really true? If you are unsure whether passively managed funds are the right choice, let us help you out.
What are passively managed funds?
Before making any decision, the first thing you should know is what passively managed funds are. In actively managed mutual funds, fund managers make decisions on which stocks to buy and which ones to sell. However passive funds work differently as they follow a specific market index. They just replicate the markets’ performance.
There are two types of passive funds:
- Index Funds
These mutual funds track a specific index like the NIFTY 50 or Sensex. They aim to match the returns of the index they follow.
- ETFs (Exchange-Traded Funds)
These work like index funds but trade on the stock exchange just like stocks. This means you can buy and sell them at market prices throughout the day.
Why are investors choosing passive investing?
- Lower costs
One of the biggest reasons investors are going for passive funds is the lower expense ratio. Actively managed funds have fund managers and research teams.
They also have higher transaction costs which leads to higher fees. Whereas passive funds just follow an index so they don’t require constant buying and selling of stocks. This keeps the costs low and lets you retain more of your returns.
- Consistent performance
Actively managed funds depend on the fund manager’s decisions and sometimes they get it wrong. You don’t have to worry about human errors or market predictions with index funds and ETFs. They track the market consistently which has historically shown growth over the long term.
- Simplicity and transparency
If you have ever looked at the portfolio of an actively managed mutual fund you’ll notice how complicated it can be. With index funds and ETFs, you know exactly what you are investing in. If you pick a NIFTY 50 index fund then you can easily check the 50 stocks it holds. There are no surprises.
Should you choose index funds or ETFs?
While both have similar objectives there are some differences.
- Liquidity and trading
ETFs trade on the stock exchange so you can buy and sell them at any time during market hours. However index funds work like regular mutual funds where you can only invest or redeem based on the closing price of the day. If you prefer flexibility then ETFs might be a better option.
- Investment mode
If you want to invest through SIPs then index funds are a more straightforward choice. Most ETFs don’t allow systematic investment plans (SIPs) which means you’ll have to manually buy units every time you want to invest. If you plan to invest regularly then an index fund can be a better fit. You can also check your SIP return calculator for future projections.
- Cost efficiency
Both index funds and ETFs have lower costs than actively managed funds but ETFs usually have an edge. Since they don’t require fund managers to manage daily transactions their expense ratio is often lower than index funds. However ETFs have additional costs like brokerage fees. These expenses along with bid-ask spreads can add up over time.
Are passive funds the future of investing?
Passive investing has grown popular worldwide including in India. Over the past few years we have seen a significant rise in investments in index funds and ETFs. But this does not mean actively managed funds will disappear. Actively managed funds still make sense in categories like mid-cap and small-cap funds. Skilled fund managers can also find opportunities that an index might miss.
If you want a hands-off approach with stable returns then index funds and ETFs are a good choice. But if you can take risks and trust a fund manager then active funds can be worth it.
Who should invest in passive funds?
- New investors
If you are new to investing, passive funds are a great way to enter the market. You do not have to worry about selecting the right stocks or fund managers.
- Long term investors
If your goal is wealth creation over 10–20 years then index funds can be a great low-cost option.
- Cost conscious investors
If you want to save on expense ratios and management fees then passive funds are a good choice. They help you keep more of your returns.
How to get started?
Getting started with passive investing is simple. You can open an account with any mutual fund provider and look for NIFTY 50 or Sensex index funds. If you prefer ETFs you will need a Demat account since ETFs trade like stocks. No matter which option you choose make sure to know your risk appetite and investment horizon. You can also use a mutual fund calculator to compare the potential returns of different funds. This will help you see which ones align with your financial goals.
