There are various ways of investing in the market and gaining returns as per market performance. Opting for a Unit-Linked Insurance Plan or a ULIP may be one such effective way to invest in the market and gain financial security alongside. Whether you may be investing via the conventional route of a retail investment plan or through a market-linked insurance plan, such as a ULIP, an essential aspect to consider may be whether you want to park your money in active funds or passive funds.
For the uninitiated, there are two broad ways of categorising investments in the equity market: active investing and passive investing. The major difference between the two lies mainly in the investment strategy and the manner of investing practised by the fund manager. [1]
The returns you may receive on your investment may depend on the kind of strategy chosen by the fund manager, among other factors. Hence, having a clear understanding of each type of investment – both active and passive investing – may be crucial to selecting the right market-linked insurance plan and meeting your financial goals efficiently.
To help you pick the suitable option, we have compared active investing vs passive investing.
What is active investing?
Active investing involves a fund manager/investment manager being actively involved in the stocks that are a part of the investment plan or market-linked life insurance policy. The fund manager usually operates with the intention to choose the appropriate stocks for the plan to maximise returns and minimise risks for the investor. The fund manager selects a benchmark index which is a standard against which the performance of a security, investment strategy, or investment manager can be measured. The investment may be carried out with the aim to surpass the benchmark returns of the index in which the selected stocks are listed.
In addition to choosing which stocks to add and which to remove, the fund manager may also decide the concentration of different kinds of stocks in the plan in active investing.
What is passive investing?
In the passive investment strategy, the fund manager may have little to no control over how the fund is managed. The funds of a passive investment plan may not be expected to beat the benchmark. Rather, the fund tends to follow the trajectory of a particular index and ensures that the fund tracks the index correctly.[3]
The role of a fund manager in a passive investing strategy may be mostly limited to ensuring that the fund is in line with changes in selected benchmark index and plan’s terms and conditions. [4]
Though index funds constitute a large portion of passive investing, there are other kinds of passive funds as well. [5]
Difference Between Active and Passive Investment
After going through the basics, let’s understand the differences that arise after pitting active vs passive investing:
• Risk factor
Any investment made in the equity market are likely have an element of risk attached to it. The performance of your funds may depend on a host of factors, many of which may not be within your control, regardless of the investment strategy you opt for. Nevertheless, active funds may have a higher element of risk since the aim of the strategy is to usually surpass the benchmark.
To achieve the aim, the fund manager may choose some stocks that have a higher risk element. Though passive funds may often be considered to have lower risks6, there is one thing you still have to keep in mind, is that the risks may increase depending upon the market situation. At times, passive funds may be more adversely affected than active funds.
• Returns
An active investment plan may have better returns since its objective is to usually surpass the benchmark returns of the index.
Passive funds may only aim to track the index rather than surpass it, and so, the returns here may be lower. However, one may remember that there may be multiple factors that may have a positive or negative impact on the fund performance, whether the fund manager is following an active strategy or a passive strategy.
One may also look at the past performance of a fund to get a better idea; however, it may not be indicative of future yields, so one should ideally proceed with care.
An investment calculator can give you an estimate of the returns you may expect with different kinds of funds.
Now, which one should you pick?
As you may have observed, after contrasting active vs passive investing, pros and cons may be observed. Which type of investment plan would be suitable for you depends on several subjective factors unique to each investor, such as their investment goals, risk appetite, expense budget, and so on.
Hence, before opting for an active or passive ULIP or retail investment plan, one may consider these factors and proceed accordingly.
Also, one should remember that investing in the market, especially in equities, is fraught with risk. However, one may minimise this risk and maximise their returns by being careful with picking the suitable funds, using the investment calculator, and following the advice of experts.
Knowing the differences between active investing vs passive investing may help you in making the right additions to your investment portfolio. Hence, ensure to use the information presented here correctly to meet your goals and secure your financial future.
Ref:
1. https:/cleartax.in/s/active-vs-passive-portfolio-management#:~:text=Fund%20managers%20are,a%20benchmark%20index.
2. https://cleartax.in/s/active-vs-passive-portfolio-management
3. https://cleartax.in/s/active-vs-passive-portfolio-management#:~:text=The%20idea%20here%20is%20not%20to%20outdo%20the%20benchmark%20but%20to%20generate%20returns%20that%20are%20in%20line%20with%20it.
4. https://groww.in/p/difference-between-active-vs-passive-investing#:~:text=Say%20if%20Sensex%20goes%20through%20a%20rejig%2C%20the%20fund%20manager%20will%20have%20to%20make%20the%20same%20adjustment%20in%20his/her%20fund.
5. https://www.indmoney.com/articles/mutual-funds/passive-mutual-funds-in-india
6. https://cleartax.in/s/active-vs-passive-portfolio-management#:~:text=High-,Low,-Suitability
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