Index funds vs managed funds - pros and cons

Mutual funds are investments wherein funds accumulated from multiple investors are invested together into a bouquet of investment instruments. These funds are usually managed by portfolio managers who decide the best way to invest money into funds based on investors’ risk appetite as well as the tenure they are looking to invest for. The tenures are generally dictated by whether investors are aiming to achieve their long-term or short-term goals through these investments.

Mutual funds are generally considered the best investment plan because they invest across funds which allows them to drive higher returns than would have been possible by investing in a specific kind of security. Of these, index funds and managed funds are two different types of mutual funds. Index funds are passively managed funds, which pools the entire fund into buying stocks in a particular benchmark index. The fund thus, mimics the results of the fund’s performance and investors get returns based on this index alone.

An actively managed fund involves the portfolio manager attempting to outrun the market performance by actively investing in different funds. This requires the manager to be actively involved in studying the market, and then taking decisions to ensure the highest returns.

Read on to learn the differences between an index fund, which is passively managed, and an actively managed fund. Comparing the differences between the two will give you a better idea on the best way to invest money in mutual funds which are generally considered the best investment plan.

1. Outperforming the market:

While index funds mimic the performance of the index and thus the market, managed funds have the potential to outperform the market. This is because actively managed funds have a fund manager who is consistently studying the market and identifying ways to get higher returns. This can be done by constantly shifting the fund allocation towards funds that have the potential to generate higher returns. Index funds on the other hand are tied to the performance of the index and thus generate returns according to its performance. A study by U.S.A.-based investment management firm Vanguard found that for the 10-year period ending December 2018, index funds did much better than their actively managed counterparts. While outperforming might be the goal behind actively managed funds, they need not always lead to higher returns than index funds.

2. Cost:

The cost of investing in a managed fund is higher than an index fund, because the fund manager will charge a higher commission fee if they are expected to actively shift fund allocation in response to market activities. With an index fund, managers charge lower fees since the allocation is already set to follow a benchmark index and does not require the manager’s active intervention. Investing in mutual funds on Finserv MARKETS also allows investors to skip commission fees altogether by investing in a Direct Investment Plan, wherein they can decide the allocation of funds themselves. This, however, requires investors to be market savvy in order to generate the higher returns while also ensuring security of their funds.

3. Tax Efficiency:

In an actively managed fund, the fund manager buys and sells shares quite frequently in a bid to generate higher returns. This results in more incidences and thus higher taxation of capital gains, which can be avoided by investing in an index fund where allocation happens just once during the fund tenure. If your goal is to keep ancillary expenses such as taxation low while generating higher returns and at the same time, ensuring security of your fund, then a passive index fund is your best bet.

Both index and actively managed funds have different advantages and disadvantages, as detailed above. The best way to invest money always depends upon the investor, their knowledge of the market, their goals as well as their risk appetite. Most mutual funds have to be invested into for a significant period of time before their performance truly can be judged, and as such the investor’s risk appetite becomes the most important consideration for deciding between an actively managed and a passive index fund.

Investing in mutual funds on Finserv MARKETS allows investors to choose between a bouquet of funds, and decide on the best investment plan. Investors can choose to avail the services of qualified fund managers, who can advise, guide and invest the money; while investors can also choose to invest based on their own discretion. This way, the zero commission fees will ensure that they can fully get their returns without any deductions.

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