Why Passive Funds Could Be the Key to Long-Term Wealth

Active mutual funds are essentially those where there is a thesis/ view of the market, either concentrated, or overweighted or contrarian and a fund manager actively seeks to manage it. “But as markets become more efficient, finding opportunities that are outliers becomes harder, and sometimes leads to an analysis paralysis, wherein investing in the general trend seems like the more prudent approach,” says Saksham Malik, Founder, Rabbit Invest, an AI led mutual funds advisor. 

The Case For Passive Funds 

Here is where passive funds come in. Passive funds are where there is minimal management and systematic checks to follow a certain index. “They can be both regular index mutual funds or ETFs, but in principle, there is no active manager calling the shots, just a passive program, keeping the holdings in check to exactly which index its tracking,” says Malik. 

“Suppose if it is in a large cap and 15 per cent money is in HDFC bank by the index, definitely the passive fund will invest 15 per cent into HDFC bank as per the index,” says Soumya Sarkar, Co-Founder, Wealth Redefine, AMFI registered MFD).

So, the number one benefit is a low expense ratio. Usually, passive funds are managed by the computer so hence it doesn't require an active fund manager.  “That is one of the reasons that passive funds are very low in terms of expenses. When you have very low expenses actually it gets added to your income,” says Sarkar. 

Let us suppose a fund and an active fund is giving a similar return of 15 per cent. However, the passive fund has an expense ratio of 0.10 and the active fund has an expense ratio of 1.5. In the case of the passive fund your return is 1.4 per cent higher. 

A Powerful Tool 

Investing in passive mutual funds offers a powerful path for those seeking steady growth with low intervention. By aligning with benchmark indices, passive funds bring stability and consistency to a portfolio, making them an ideal choice for investors with long-term goals. 

Passive plan doesn't hold any kind of cash, so when the bull market continues, passive funds generate a better return because in an active fund, the fund manager holds 10 percent or 15 cash but in passive funds there is such cash holding. 

“Notably, passive funds have outshone their active counterparts in recent years; according to the 2024 S&P Indices versus Active (SPIVA) Scorecard, nearly 80 per cent of active funds underperform their benchmarks. This further underscores the advantage of passive funds, which track indices like the Nifty 50, yielding market-aligned returns,” says Krishna Makhariya, CFA - Executive Director and Head of Research at iVentures Capital, a wealth management firm. 

Consider the wealth generated by a Rs 50,000 monthly SIP in the Nifty 50 over the past decade—an investment that would have grown to Rs 1.4 crores by today. Even more impressive, a similar SIP in the Nifty Alpha 50 index would have achieved Rs 2.7 crores. By offering a balance of returns. 

How To Select Passive Funds 

Selecting the right passive mutual fund requires a careful look at a few critical aspects to ensure it aligns with your investment goals and risk tolerance. “One of the first factors to examine is the fund's concentration. In some sector-specific or thematic funds, a high percentage may be tied to a handful of stocks, which can signal higher risk if these stocks underperform. Likewise, the fund’s exposure to mid and small caps can increase volatility—especially in equal-weighted funds—so investors should be comfortable with this potential for fluctuation,” says Makhariya. 

Tracking error is another key consideration. “This metric shows how closely the fund follows its benchmark; lower tracking error typically indicates better alignment. Fund experience can also play a role, as seasoned fund houses often manage tracking error more effectively. “Finally, investors should evaluate the type of passive fund—whether broad-based indices, sectoral, or factor-based funds—to ensure the choice aligns with their risk profile. Choosing a fund that fits your comfort with risk and market cycles is essential for long-term stability and growth,” says Makhariya.