Mutual funds are one of the best market-linked investment options that are currently available. They offer adequate diversification of risk and have the potential to generate multifold returns in the long-term. However, if you’re looking to invest in mutual funds, you should be able to differentiate between the various types available in the market.
Yes, you read that right, there are two different types of mutual funds that you can invest in - active mutual funds and passive mutual funds. Want to know more about passive mutual funds? Here’s what you need to know.
In the case of a typical mutual fund, it is actively managed by a fund manager. The manager is responsible for selecting the basket of stocks to invest in, the amount of investment to be allocated to each stock, performance monitoring, and periodic balancing, among others.
However, in the case of passive mutual funds, there’s usually no need for a fund manager. This is due to the way passive mutual funds are constructed. Almost all passive mutual funds track an index like Sensex or Nifty 50. What this essentially means is that these mutual funds consist of stocks that mirror those contained in indexes.
Therefore, if the index goes up, the Net Asset Value (NAV) of the mutual fund also goes up and vice versa. And once the passive mutual fund is constructed, it rarely requires any intervention. This is one of the reasons why they don’t have any fund manager.
Passive mutual funds come with several advantages over other different types of mutual funds. Let’s take a look at a few of them.
1. They come with lower costs
Since passive mutual funds usually don’t have a fund manager, the costs associated with mutual funds tend to be far lower compared to an active fund. This makes them a very attractive proposition for investors.
2. They tend to outperform in the long-term
As you’ve already seen above, passive mutual funds track an index like Sensex or Nifty 50. And as such, they tend to outperform a basket of stocks in the long-run. So, if long-term wealth creation is what you’re looking for, then passive mutual funds may just be the perfect option for you.
3. They offer exceptional diversification
While an actively managed mutual fund offers diversification, it is nowhere near that of a passive mutual fund. This is because passive mutual funds track indexes, which consist of the best stocks from almost all the sectors and industries. This tends to lower the risk in a much better manner than other different types of mutual funds.
If long-term wealth creation with a low amount of risk is what you’re interested in, then invest in mutual funds that are passively managed. That’s not all. If you’re a beginner to the world of stock trading, investing in passive mutual funds may just be the perfect option for you since it doesn’t require much in depth knowledge of how the markets work.
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