Posted in Investing, Personal finance

Active vs Passive Investing

There is a continuous debate that goes on in the context of investing through mutual funds.

Should I choose funds which are actively managed or choose Index funds which simply mirrors an index?

Some experts are strongly opinionated in favor of Index funds, whereas investment firms will always tout active investing for obvious reasons.

So what should we as investors choose?

Let’s see the different reasons why Index Funds are better choice for most investors.

  • Index Funds simply cost much lesser yet gives you the returns of the market.
  • Index Funds provide instant diversification from flavors such as Total market Index to specific themes and international market indices.
  • Index Funds do not have the need to reward performance and compete with other funds.
  • Index Funds do not need to trade very often, thus saving unnecessary tax liability due to capital gains.
  • Index Funds are simple to understand and follow.

So in an efficient market like the US, where information about good companies is widely available, beating the benchmark indices is not easy for fund managers. There are star fund managers who may have done that, but the percentage is very less, typically < 5%.

The simplest and most convenient in the US is the proverbial Bogleheads’ Three fund portfolio. 

https://financinglife.org/best-books-on-investing/bogleheads-guide-three-fund-portfolio

However the story may be different in other parts of the world, for example, emerging markets like India.

There are evidences of active fund management overtaking Index returns and in the short to medium term, even with the high costs of management, beat the index fund often.

However this is slowly changing and in recent years, the Index Fund is tilting to be the better choice for long term investors.

With more institutional money flowing into Index Funds as well, Fund managers will find it difficult to beat the index returns and the market efficiency will move towards that of developed markets like the US. To quote an article, it clearly shows the trend.

Over the last couple of years, many investors have increased exposure to index funds as returns from several categories of actively-managed funds failed to beat the Nifty 50 returns. In the past one year, the Nifty 50 has returned 12.51%.

 

Thus no matter where you are investing, Index Funds are the simplest and the most efficient choice for a portfolio.

Index fund investing is like sticking to the basics, just invest for a very long term and you need not worry about the noise of the investment world.

composition of different conchs on beige table
Photo by Karolina Grabowska on Pexels.com

Photo by Karolina Grabowska on Pexels.com

Author:

I am a software engineer by profession and a personal finance enthusiast by passion. I read a lot and like to write about my experiences about applying what I read. One day I hope to positively impact a few lives by my positive thoughts about personal finance.

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