Index funds vs actively managed funds- Which should you opt for?

Last Updated : June 22, 2016, 11:34 a.m.

Mutual funds are a great medium to grow your money with the help of fund managers who cut out the risk element by diversifying your investment across securities such as stocks, bonds, etc. Not only you receive good return but also the risks get minimised, making you laugh all the way to the bank. But if you want to go without seeking the help of fund manager, then you can look to invest in index funds. We, in this article, will do a comparative study of both the funds in terms of operational methodology, feature, benefits, pitfalls, etc. First check out how they work?

Operational Methodology

Index funds are the type of equity funds that follow a particular index such as BSE, NSE, etc. These funds invest in the same stocks and in the same measure as that of index. For instance- If you make an investment in index fund that follows the National Stock Exchange (NSE) index, you will be indirectly investing in 50 underlying stocks that constitute the said index. Similarly, you will be indirectly investing in 30 stocks if you invest in an index fund that follows the Bombay Stock Exchange (BSE). Here, you do not have the support of the fund manager or the scheme objective.

While in the case of an actively managed fund, you get the support of fund manager who pick the best stocks, bonds and other securities that would have the means to meet the objectives of the scheme. Fund manager appointed by the Asset Management Companies (AMCs) undertake the responsibility of monitoring your portfolio and taking decision on a timely basis so that you get better returns on your mutual fund investment. However, the fund manager must be well versed with the risks that come with mutual fund investments so that he can take a calculative decision to prevent your returns from getting eroded.

After discussing the operational methodology, let’s get down to analyse both index funds and actively managed funds on various parameters.

Investment Cost

You can reduce costs like brokerage, transaction fee, etc, with an index fund. In the absence of a fund manager, fund management charges and the resulting expenses ratio are quite lower in the case of index fund. The average expense ratio of index funds ranges around 1%-1.5%, much lower than 2%-2.5% in the case of actively managed funds, which account for charges of brokerage, commission, etc.

Selection of Performing Securities

Actively managed funds pick the securities carefully and thus reduces the scope for the inclusion of under-performing securities in the portfolio. But with index funds, chances are huge that they could fall if the market nosedives.

Investment Approach

Actively managed funds stand to gain the most from the experience of fund managers who through a structured investment approach can analyse the trends existing in the market. And based on the trends, the fund managers can make a strategic decision, which could enhance the performance of an actively managed fund. But the same investment approach is not expected in an index fund due to the lack of a fund manager.

Fund Manager Risk

There is quite a possibility that the concerned fund manager may make a poor decision with regards to picking the stocks. This can adversely affect your investments in actively managed funds. Index funds, on the other hand, nullify that risk by investing passively in those securities that feature in a particular index.

Trading

Like most mutual funds, actively managed fund can be traded only on net asset value (NAV), which gets declared at the end of the day. But since index funds are traded on stock exchanges, you can buy and sell the funds at any time and receive the benefit of real-time prices.

Actively managed funds are known to perform better than index funds because of the rich vein of expertise that comes with a fund manger. However, poor decision by him/her can lead you to a loss. So, choose the option after carefully assessing your risk appetite and investment objective.