Five Myths About Passive Mutual Funds Schemes Busted

All of us save some part of our earnings and invest to achieve our time-bound financial goals. So, where do you invest your surplus? Broadly speaking, it depends upon your risk profile, investment objective, investment time horizon, personal aspects and macroeconomic factors. There are various asset classes to invest in. Exposure in suitable asset classes can be taken through various investment vehicles. Mutual Fund is a very common vehicle among others. Within Mutual Funds, passive Mutual Funds are gaining popularity in India. As practicing Certified Financial Planner in Kolkata, we are observing that many have various myths about passive Mutual Funds schemes in India. This article is intended to bust 5 myths about passive investing.

Before discussing about the myths, let’s understand the basics of passive Mutual Funds schemes.

You must have heard, “Today market has gone up.” What does this mean? Market here refers to stock market. Stock market movements are indicated via a stock market index viz. Sensex, Nifty 50, etc. So, when Sensex and/or Nifty 50 go up, you get to hear that market has gone up. The ups and downs in Sensex indicate the performance of 30 stocks in the portfolio. Again, the ups and downs in Nifty 50 indicate the performance of 50 stocks in the portfolio.

A passive Mutual Fund scheme is a portfolio of stocks or bonds aimed to mimic the composition and performance of a financial market index.

XYZ Index Fund-Sensex Plan mimics the composition and performance of Sensex index.

ABC Index Fund-Nifty 50 Plan mimics the composition and performance of Nifty 50 index.

Please note that apart from Index Fund-Sensex Plan or Index Fund-Nifty 50 Plan, there are many other Index Funds.

To develop financial awareness, let’s figure out the myths.

Bust Your Myths About Passive Mutual Funds

Myth #1

Passive Mutual Funds schemes are risk-free

As Financial Advisor in Kolkata, we get to hear that many perceive Passive Mutual Funds schemes as a risk-free product to invest in. It’s one of the strange myths about Passive Mutual Funds schemes.

Equity markets are subject to systematic risks. Portfolio of Passive Mutual Fund schemes consists of stocks. How can systematic risks be avoided by investing in Passive Mutual Fund schemes?

Myth #2

Passive Mutual Funds schemes are better than actively managed Mutual Funds schemes or vice versa

Equity investments are suitable for the long run. In this journey of wealth creation, certain actively managed Mutual Funds schemes will do well and beat the benchmark comfortably for a certain period of time. Some schemes will fail to match or beat the benchmark for some time. Later on they may or may not cope up. It varies on Fund Manager’s calls.

With this, we cannot conclude that Passive Mutual Funds schemes are better than actively managed Mutual Funds schemes or vice versa.

As SEBI Registered Investment Adviser in Kolkata, we believe that both can co-exist. An investment portfolio can be constructed with actively managed Mutual Funds schemes and Passive Mutual Funds schemes. The investment strategy depends on the suitability and need of the investor. Herd behavior should be avoided at all cost and approach can always be dynamic for the better.

Myth #3

Passive Mutual Funds schemes are best for first time investors

It’s absolutely one of the major myths about Passive Mutual Funds schemes among many. Passive Mutual Fund schemes are not only for beginners. Just because it’s cheaper and/or easier to track, it cannot be the “best” option for any investor, be it a first-timer or a seasoned investor.

As part of the overall investment plan, if Passive Mutual Fund schemes are suitable for your specific needs, it should be part of the investment portfolio. As Financial Consultant in Kolkata, we advocate that these schemes are not restricted to any specific category of investors.

Myth #4

Passive Mutual Funds schemes are good options only during specific market cycles

When it comes to investing, discrete performance should never be considered in isolation. This may lead to unsuitable investment decisions. As Fee Only Financial Planner in Kolkata, it would be wise to highlight that theory may not always hold true in practice. We get to hear from many places that Passive Mutual Funds schemes are suitable only in specific market situations (eg. in bear markets).

Woollen garments are suitable in winter seasons. If one applies the same theory here – Passive Mutual Funds schemes are suitable only in bear markets, then it can be a wrong notion.

Myth #5

Passive Mutual Funds schemes generate exact returns as the index

It is a fact that Passive Mutual Funds schemes intend to closely replicate the index. But, you will notice a difference between the index return and the scheme return. Thus, return from index fund cannot match with that of index. The reason for the same is tracking error. The index fund needs to hold cash for redemption or to buy a stock and there’s mutual fund expenses etc.

Product selection is undoubtedly an important activity. But, foremost step is to know how to set your investment objectives.