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Active vs. Passive vs. Balanced Funds: Which is Right for You?

Written by - Akshatha Sajumon

May 13, 2023 9 minutes

Investing can be a scary endeavor without a road map. Each investor has a different mindset when they invest. The final goal of an investor must be to choose funds planned as per his/her financial goals and strategies. Here is the breakdown of how one should opt for active or passive funds when it comes to investment.

Why it’s important to choose the right mutual fund

Choosing the right mutual fund is of paramount importance as it directly impacts your investment outcomes. A well-selected mutual fund aligns with your investment objectives, risk tolerance, and time horizon. It provides the potential for favorable returns while managing risks effectively. By carefully evaluating factors such as the fund’s investment strategy, historical performance, expense ratios, and fund manager’s expertise, you can increase the likelihood of achieving your financial goals and maximizing your investment’s growth potential. Making an informed decision when selecting a mutual fund is crucial for long-term investment success.

Overview of active, passive, and balanced funds

Active funds are actively managed by professionals who aim to outperform the market through research and analysis. They select and trade securities to generate higher returns, but their fees tend to be higher. Passive funds, on the other hand, aim to replicate the performance of a specific market index, requiring less active management and therefore lower fees. Balanced funds combine both equity and fixed-income securities to provide a balanced mix of growth and income. The choice depends on individual preferences, risk tolerance, and investment goals. Active funds seek outperformance, passive funds offer cost-effectiveness, and balanced funds aim for a middle ground between growth and stability.

What are Active Funds?

Active investing is a strategy that involves buying and selling assets to make profits that outperforms and sets the benchmark in the index. A fund manager is an example of an active investor.

Pros and cons of active funds

Investors in actively managed funds will have to pay higher annual charges for the expertise of the fund manager, the interest is usually between 0.6% to 1.5%, and sometimes it could be more, depending on the type of the portfolio they are running. So it is up to you to decide whether the cost of a fund investment is worth the potential returns you could receive.

Example of active funds

In India, an example of an active fund is the HDFC Equity Fund. This fund is actively managed by experienced professionals who analyze the market and select stocks based on their research and insights. The fund manager makes buy and sell decisions with the aim of outperforming the benchmark index. For instance, if the manager believes a particular sector or company is poised for growth, they may allocate a higher percentage of the fund’s assets to those stocks. Similarly, if they anticipate a downturn in a specific sector, they may reduce exposure to mitigate potential losses. The active management approach of the HDFC Equity Fund aims to deliver superior returns compared to passive strategies that track the market index.

What are Passive Funds?

Passive investment is excellent for the beginning newbie investor because it provides diversification at a minor cost. Where buying and selling transactions are limited to minimize transaction costs and capital gains taxes. Passive funds are seeking long term capital appreciation with limited activity.

Pros and cons of passive funds

In short passive fund management delivers a return in line with how the tracked index performs. The main reason why this type of fund appeals to investors is that it offers them complete access to the markets that these funds mirror at a low price when compared to active funds. Some passive funds carry as low as around 0.1%. However, it’s worth in mind that passive funds will always marginally underperform their index once costs are taken into account.

Example of passive funds

In India, an example of a passive fund is the ICICI Prudential Nifty Next 50 Index Fund. This fund aims to replicate the performance of the Nifty Next 50 Index, which represents the top 50 stocks beyond the Nifty 50 index. The fund invests in a diversified portfolio of stocks that mirrors the composition of the index. The holdings and weightage of stocks in the fund are adjusted periodically to match the changes in the index. As a passive fund, the ICICI Prudential Nifty Next 50 Index Fund does not involve active stock selection or timing decisions. Instead, it aims to provide investors with returns that closely align with the performance of the Nifty Next 50 Index, allowing investors to gain exposure to a broad segment of the market without the need for active management.

What are Balanced Funds?

Balanced funds are a mixture of equity and debt exposure where the allocation of money is in both debt and equity in a particular proportion. The proportion of equity and debt depends on the type of fund you choose to invest.

How do balanced funds work?

Balanced funds invest in debt and equity, but still, they are low-risk profile to invest in. The main advantage an investor gets is the benefit of diversification. Investing your funds into equity is where the risk is uncertain; one should invest in balanced funds where it helps the investors to invest their funds at low risk.

Example of balanced funds

For example: Assuming 60:40 (debt: equity) ratio where 1 lakh is the investment in that 60000 thousand would be invested into debt, and 40000 thousand would be invested into stocks.
Note: This is only for illustration; this may vary depending on the investment objective or market situations.

Advantages of balanced funds:

  1. The balanced fund is designed well and appropriate for small investors who are ready to put in a small number of their monthly investments.
  2. It is best suited for first-time investors who have very little knowledge of fund management. The funds are managed by expert and skilled professionals who keep an eye on the market and make the best decision for your investment.
  3. Balanced funds are such an investment option that permits the investor to take systematic withdrawals, although upholding appropriate asset allocation is best suitable for people close to retirement.
  4. Balanced funds cost the efficient option to diversify the funds among different variants of stocks and bonds. It is a hassle-free solution for investors where one doesn’t have to analyze and select every fund separately; instead, the investor gets a single fund portfolio which is further diversified.
  5. The balanced funds offer a reduced risk investment portfolio acquired with the help of diversified funds. The funds are invested in various securities and bonds.

Disadvantages of balanced funds:

  1. The investors have no authority over the choice of funds. They cannot make decisions like how much investment is bonds (corporate or government bonds) or stocks (large-cap or small-cap).
  2. Many people believe that balanced funds are riskless investment option which is not entirely true, they are no entirely risk-free instead they are less volatile and have own risk chances
  3. An investor who holds a specific class of funds can move off their resourced to different mutual funds for wealth creation or maybe for tax planning. Though this is not possible with balanced funds because similar mutual funds hold both bonds and assets.

How to choose the right mutual fund for you

Choosing the right mutual fund in India involves careful consideration of several factors. Here’s a guide on how to make the right choice:

  1. Define your financial goals: Determine your investment objectives, such as capital appreciation, regular income, or wealth preservation, as different funds cater to different goals.
  2. Assess your risk tolerance: Evaluate how much risk you are comfortable with. Aggressive investors may opt for equity funds, while conservative investors may prefer debt or balanced funds.
  3. Consider investment horizon: Determine the time duration for which you can stay invested. Longer-term goals may warrant equity funds, while short-term goals may require debt or liquid funds.
  4. Research fund performance: Analyze the historical performance of funds by reviewing their returns over different time periods. Look for consistency and compare with benchmark indices.
  5. Understand fund types: Familiarize yourself with different fund categories like equity, debt, balanced, or sector-specific funds, and choose based on your risk profile and investment objectives.
  6. Review fund expenses: Consider the expense ratio and other charges associated with the fund, as higher expenses can eat into your returns over time.
  7. Evaluate fund manager expertise: Look for experienced and skilled fund managers with a proven track record of delivering consistent returns.
  8. Check fund ratings and reviews: Consult independent rating agencies and read reviews from reputable sources to gain insights into the fund’s performance and reputation.
  9. Diversify your portfolio: Consider diversifying your investments across different asset classes, fund houses, and fund managers to reduce risks and optimize returns.

How to invest in the right mutual fund in India

On Fisdom , you can build your wealth by investing your funds in balanced funds, either via SIP or one-time investment. All you have to do is invest a certain amount according to your investment goals.

  • If you are an investor with low-risk bearing capacity, then you should invest 50% in stocks and 50% in bonds in this the returns would be moderate.
  • If you are a person with moderate risk-bearing capacity, then you should invest 60% in stocks and 40% in bonds where the returns are moderately high.
  • If you are an investor with high-risk bearing capacity, then you should invest 80% in stocks and 20% in bonds where you would be getting high returns.

Stop fearing risk, instead remember to stay invested for a long term and leverage the benefits of balanced funds through Fisdom , India’s most trustworthy app.

Related  Links

Passive Investing Vs Active Investing – How do you choose?
Best Balanced mutual funds to invest in 2021
How to check current balance on EPF?
7 pillars of passive investing
Why passive funds may gain traction?

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