‘Passive investing’ means investing in passive funds. Unlike active funds, fund managers do not actively manage passive funds.
So, how does a passive fund generate returns? Passive funds try to replicate the growth of a market index, called a benchmark index by investing in similar securities as that of the index. A market index is a hypothetical portfolio of investment holdings in a market segment. Thus, a passive fund’s portfolio will contain stocks or securities of similar weightages as its chosen benchmark index.
Passive funds generate returns similar to their benchmark index. If you want to invest in mutual funds for the long term, go for a passive fund. Read this article to learn why.
Buy and hold
Passive investing follows the principle that market indices tend to grow upwards over a long period. For instance, Sensex was around 5000 points in the 2000s, but currently it stands at 56k points.
Thus, passive investing allows you to buy and hold your assets for a long time instead of changing market strategies and risking your returns. Therefore, passive investing can profit those who remain invested for long durations.
Additional Read –Why are SIPs an Ideal Choice for the First-time Investor?
Superior returns in the long term
When it comes to passive vs active investing, the former often wins in the long term.
Fund managers of active funds try to beat the returns of a benchmark index. However, in recent years, active funds have underperformed in the long term. As per a report by SPIVA (S&P Indices versus Active), the performance of Indian equity-oriented funds in the large-cap category over 10 years is 7.98%. Meanwhile, S&P BSE 100 index delivered a 10-year CAGR of 8.13%.
Passive investing entails mirroring the portfolio of a market index.
This strategy ultimately diversifies your investment portfolio across sectors and companies. Thus, you are safe from sector-specific or company-specific downturns.
When you invest in active funds, you pay a fee to the fund manager, known as the expense ratio. This expense ratio is a percentage of your returns. Since fund managers do not actively manage passive funds, their expense ratio is low.
When you invest in any passive fund through SIP route, you get the benefits of compounding and get substantial returns in the long term.
So, for an active and passive fund that generates the same amount over the same period, your returns will be higher in passive funds because you will not have to pay a hefty expense ratio.
Additional Read – Understanding the Power of Systematic Investment Plan
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