Understanding Passive Mutual Fund Schemes: Myth vs. Reality

Do you want a straightforward and low-cost approach to participate in the financial markets? Looking to gain from long-term market growth instead of making money from short-term price fluctuations? Harnessing the advantages of passive mutual fund schemes can assist you in creating a diversified and perhaps rewarding investment portfolio.

 

In recent years, passive mutual fund schemes have become increasingly popular as a wise and reliable investment choice. Also referred to as index funds or exchange-traded funds (ETFs), passive funds are investment vehicles that mimic the performance of a particular market index. With the least amount of active management necessary, these funds offer investors an excellent way to benefit from the growth of the stock market. However, passive mutual funds have also been the target of numerous misconceptions, much like any other form of investment.

 

Thinking of investing in passive funds but worrying about the things you have heard? Read on.

 

Myth 1: Passive Mutual Funds Provide Lower Returns

 

One widespread misconception about passive funds is that they offer lower returns. This falsehood is a result of the belief that active fund managers can outperform the market constantly. But several studies have shown that most active fund managers struggle to outperform their respective benchmarks over the long term constantly.

 

The truth is that passive funds offer investors market returns, which can be very competitive. These funds’ returns closely mirror the performance of the whole market because they aim to mimic the performance of a particular index. Additionally, in comparison to active funds, passive funds generally have lower expense ratios which can further increase the net returns of investors.

 

Myth 2: Passive Funds Lack Portfolio Diversification

 

Another misconception about passive funds is that they lack diversification. Some investors think that passive mutual funds' portfolios may be restricted to a small number of stocks or industries because they try to replicate a particular index.

 

Passive funds, however, aim to give broader market exposure. They often maintain a diversified portfolio of investments that closely resembles the index they follow. With this strategy, investors are exposed to a broad range of industries, stocks, and asset classes. As a result, passive funds can offer a level of diversification comparable to actively managed funds.

 

Myth 3: Passive Mutual Funds Are Suitable Only For Novice Investors

It's a common misconception that passive mutual fund schemes are the best for novice investors. Although passive funds are a great choice for first-time investors, the opposite isn't always the case.

 

The truth is that investors with different investment horizons can benefit from passive funds. These funds offer an affordable and effective way to get exposure to the entire market. Passive mutual funds can be a useful addition to a portfolio for investors who are interested in short-term exposure as well as those who have long-term investment goals.

 

Myth 4: Passive Funds Are A Risk-Free Option For Investing

 

Passive mutual funds are believed to be a risk-free investment by many, which is one of the strangest myths about them. We are aware that passive investing only follows the index and does not involve active stock selection. Consequently, fund management has lower expenses, which lowers the expense ratio. However, this does not imply that there is no risk associated with passive investing because active fund management is not utilised with a passive instrument.

 

Risks are systematically present in equity markets. When investing abroad, they may include currency risk, interest rate risk, political risk, geographical risk, or economic cyclicality. These market risks are effectively controlled through sensible asset allocation and diversification.

 

Myth 5: Passive Mutual Funds Produce Exact Returns As The Index

 

The goal of passive mutual fund schemes is to closely resemble the index, which is a fact. Theoretically, passive investment tools generate returns that are identical to the index. But you'll see that the index return and the scheme return are different. A specific passive fund might not always be able to match index returns due to a variety of factors, such as the need for an index fund to keep cash on hand for redemptions, mutual fund costs, or the inability to purchase stocks at index prices.

 

Passive funds' performance might not exactly match that of their index due to these factors. Tracking error, a metric to be taken into account when choosing a passive fund, is the term for this deviation.

 

Conclusion:

 

Despite the widespread misconceptions about passive mutual funds, the truth is that they have a number of benefits, including broad market exposure, lower costs, and reliable returns. Investors can choose to include passive mutual fund schemes in their investment portfolios with confidence by understanding the facts and dispelling common misconceptions. Invest in mutual funds with Inbest, a team of knowledgeable financial advisors!

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