With investments in the stock market touching new highs in India, the debate around the merits of active and passive fund management has become mainstream in the micro-finance world. The difference between the two approaches lies in the manner in which securities -- shares, bonds, and other assets -- are managed. For an investor, it is crucial to understand both paths before deciding on future investments.
As the basic objective of this approach is to "beat the market", active fund management requires people to take a leap of faith. The "high risk, high return" phrase works here. This is especially rewarding when the markets are rising.
Since active fund management requires relentless selling and buying, the transaction cost of the cumulative trades would be higher. Not to forget, there is no guarantee of strong returns.
Passive fund management: Under this approach, the purpose is to generate a return that is the same as the chosen index. A widely accepted way to abide by this approach is to invest in the same securities that the benchmark index is made up of.
As the securities and assets don’t change frequently, an individual doesn't need a team of experts for this approach. Also, the transaction cost for the buying and selling of securities is lower.
Index mutual funds and exchange-traded funds (ETFs) are the most popular ways of passive fund management. Contrary to active fund management, returns offered will never exceed that of the underlying index using the passive approach.
An investor can benefit from mixing both passive and active strategies. According to global financial services company Morgan Stanley, the choice between active and passive fund management really comes down to personal priorities, goals, and timelines.
