Side by side
| Index fund | Actively managed fund | |
|---|---|---|
| What it does | Holds what is in an index | Holds what its manager chooses |
| Aim | To match the market | To beat the market |
| Yearly cost, direct plan | Low, often 0.1% to 0.3% | Higher, often 0.5% to 1.2% |
| Return against the index | Just below it, by its costs | Above or below, and it varies by year |
| What can go wrong | The market falls | The market falls, or the manager picks badly |
| What you need to watch | Cost and tracking | Performance, the manager, the strategy |
| Tax | The same, for funds of the same type | |
Two ways to run a fund
An index fund follows a published list. A Nifty 50 index fund holds those fifty companies in the index's weights, and changes only when the index does. Nobody decides what to buy.
An actively managed fund employs a manager and a research team to choose shares they expect to do better than the market. A large cap fund, a flexi cap fund and a small cap fund are all active funds, each with rules on what it may hold.
Cost is the one certain difference
Active management costs more, and the cost is taken every year whether or not the manager beats the index. A difference of 0.75% a year looks small. Over twenty years it takes roughly an eighth of the final amount.
That is before commissions. A regular plan adds a distributor's commission on top, to either kind of fund. Our direct vs regular calculator shows what that costs.
Do active funds beat the index?
Some do, and some by a wide margin. The share that does varies by category and by period.
We track this with live data. Our active vs index scorecard counts, for every category, how many funds returned more than an index fund over 1, 3 and 5 years. Two cautions come with any such count. Funds that did badly are often closed or merged, so the survivors look better than the full picture. And the funds that led over the last five years are often not the ones that lead over the next five.
What each asks of you
- An index fund asks you to accept the market's return, including its falls, and to stay invested.
- An active fund asks the same, and also asks you to choose the fund, keep checking that it still deserves its place, and decide what to do when it lags.
You can see how any active fund has done against its category and against an index fund with the fund check.
You do not have to choose only one
A common approach is an index fund as the core, for a dependable share of the market at low cost, with one or two active funds where a manager has more room to add something, such as mid and small companies. The proportions depend on your goals and how much monitoring you want to do.
For the difference between index funds and ETFs, see ETF vs index fund. For help deciding the mix, talk to an advisor.