Before investing in MFs, understand which category is best for you

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In the ever-evolving world of finance, mutual funds have long been a popular investment option for individuals seeking to grow their wealth. Traditionally, actively managed mutual funds dominated the market, with portfolio managers making investment decisions in an attempt to outperform the market. However, in recent years, a new player has emerged and revolutionized the investment landscape which is passive mutual funds.

So first let us understand what are passive mutual funds?

Passive mutual funds replicate the performance of a particular market index, such as Nifty or Sensex.

Passively managed funds, unlike their actively mutual funds counterparts, do not seek to outperform the market; rather, their primary objective is to obtain returns that closely match the benchmark index.

As passive investment mimics the market, it is comparatively less volatile than active funds, making it a good choice for new investors and also for investors who prefer safety over returns.

Now lets see what are diferent types of passive mutual funds:

ETFs

ETFs are a popular form of passive fund that combines the advantages of stocks and mutual funds. By tracking an underlying index, these allow investors to acquire exposure to a variety of assets, including stocks, bonds, and commodities.

ETFs, like equities, are tradable throughout the trading day, providing flexibility and liquidity. An investor must have a demat account for transactions to invest in ETFs.

Index Mutual Fund

Index funds are an additional type of passive fund designed to replicate the performance of a particular market index. These funds construct their portfolios passively by investing in the same securities and proportions as the target index.

Index funds objective is to match the performance of their chosen benchmark, providing investors with a reliable means of gaining exposure to a broad market or sector.

The most significant difference between ETFs and index funds is that ETFs can be traded throughout the day like stocks, whereas index funds can only be purchased and sold at the NAV at end of the trading day.

Fund of Funds

– A fund of funds (FoF) is a type of mutual fund that invests in other mutual funds rather than directly in stocks, securities, commodities, and bonds.

– There are two distinct types of FoFs available. FoFs in the first category invests in domestic funds. The second type of FoF invests in funds managed by foreign fund companies registered in overseas markets.

-The fund manager selects and manages passive funds from the same or different fund houses that correspond to the investor’s risk profile. FoFs provide an easy method for investors to diversify their portfolios and reduce their risk exposure.

So, which passive mutual funds should you invest in?

While investors get to choose from a variety of index funds and ETFs, the key is to have the right mix in the portfolio. It is equally important to choose the right investment vehicle for passive investing.

According to Hemant Rustagi,  CEO of Wiseinvest, “ETFs can be a good option for those who have a Demat account and are familiar with how to transact on the stock exchange. Index funds are suitable for those who may like to buy and sell funds directly from mutual funds and don’t have much knowledge about trading, however these come with slightly higher cost than ETFs.”

That said, FOFs are taxed as debt funds and hence are not tax efficient. Besides, FOFs are more expensive than index funds ndd ETFs. However, FOFs can be a good option for investing in international markets.

Money9 suggests • The appeal of passive funds like ETFs and Index funds is so much so that you forget that it comes with risk as a mutual fund investor. That is why investors should understand what a tracking error is when it comes to passive funds.

• Before investing in passive funds, investors should see that the lower the tracking error, the better the performance of the index funds will be.

-Investors’ entire portfolios should never be made up of only passive funds. Only a small fraction of the total portfolio will be placed in these types of funds.

-Your risk tolerance and expected return determine active and passive fund allocations. Investors should see a financial planner if they can’t decide on their own.