Mutual funds are gaining popularity in the Indian market as investment options, given their track record of yielding better returns as compared to fixed deposits, public provident funds or insurance-linked investment products.
However, a new debate has now started whether one should go for passive index funds or stick to actively-managed mutual funds.
Given that most actively-managed funds have failed to beat market expectations in the last year or so, this argument has gained a lot of steam.
Most market experts are of the opinion that investing in index funds adds a lot of value to an individual’s portfolio but they also caution that one should invest only based on one’s risk profile and appetite.
But what exactly are index funds? Index funds are mutual funds that imitate the portfolio of a specific index like the Sensex or Nifty instead of the active-picking of specific stock based on anticipated performance. It means that these funds just follow their benchmark indices irrespective of how the overall market performs.
This takes most of the decisionmaking dilemmas out of the equation, making investing in equity funds extremely simple. Given their simplicity and historic performance, investment legend Warren Buffett has also recommended index funds for retirement saving plans. According to Buffet, it makes more sense for an average investor to buy all of the S&P 500 companies at the low cost an index fund offers, instead of picking out individual stocks for investment.
When it comes to returns, the main difference between a passive and an active fund is the cost involved. Index funds have a lower expense ratio since fund managers do not need to actively pick stocks or time the market.
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