Active Mutual Funds vs. Passive Mutual Funds: What's the Difference?

 For novice investors, mutual funds are a practical investment instrument that can help them achieve their financial goals because they are managed by professional investment managers. However, when interested in investing in this product, investors need to match their chosen mutual fund type to their needs and financial goals.

For example, compare investing in active mutual funds versus passive mutual funds. As their names suggest, these two types of mutual funds differ in terms of their management strategies, whether active or passive.

Active Mutual Funds vs. Passive Mutual Funds: What's the Difference?

Compared, both active and passive mutual funds can be ideal choices depending on the investor's needs. To understand the differences between active and passive mutual funds, from their definitions, portfolio management, and objectives, see the following explanation.

Definition

As the name suggests, an active mutual fund (or active RD) is a type of mutual fund product where the investment portfolio is actively managed by the Investment Manager. This means that the Investment Manager continuously conducts analysis to optimally purchase or sell investment instruments. This active management is carried out with the goal of outperforming the returns or performance of a benchmark index.

Meanwhile, a passive mutual fund (or passive RD) is a type of mutual fund product where the portfolio management simply follows or mimics the performance of a benchmark index. For example, the Investment Manager of a passive mutual fund will only manage investor capital in a portfolio that tracks the Jakarta Composite Index, LQ45, or other indexes. Therefore, the Investment Manager does not need to conduct analysis to determine the best investment instruments and simply mimics the composition of the target index.

Some examples of passive RDs are ETFs (Exchange Traded Funds) and index funds.

Differences in Portfolio Management

As previously explained, active and passive mutual funds also differ in terms of portfolio management. In active mutual funds, the Investment Manager actively manages the portfolio with selected investment instruments to achieve returns that exceed the performance of the benchmark index. This active management is based on market analysis and in-depth research.

In passive mutual funds, the portfolio is simply structured to align with the composition of a predetermined benchmark index. Therefore, Investment Manager intervention is minimal and only requires adjusting the contents of the mutual fund portfolio to the target index.

Differences Based on Investment Objectives

By actively managing funds, active mutual funds aim to achieve higher returns than the benchmark index. In passive mutual funds, the investment objective is not to maximize profits. Rather, the Investment Manager strives to achieve performance that is as similar as possible to the benchmark index.

Management Fees

Because active management involves a greater number of transactions, management fees, or expenses, are generally higher for active mutual funds than for passive mutual funds. These management fees can significantly reduce potential investor returns, although the amount may not be noticeable.

Potential Profit

Although management fees tend to be higher, active management in active mutual funds (RDAs) has the potential to yield greater profits depending on the Investment Manager's skills and performance. This is especially true if the Investment Manager's analysis is on target and the portfolio's performance significantly exceeds that of the benchmark index.

On the other hand, because they merely match the performance of the benchmark index, passive RDs tend to offer more limited profit potential. However, while they don't aim to outperform the benchmark index, the potential profit from this type of mutual fund is generally stable and easy to predict.

Risk of Loss

In terms of risk of loss, active RDs are considered to have a higher level of risk. This is due to the possibility that the Investment Manager's decisions may not always yield the expected results, especially during volatile capital market conditions that are difficult to predict due to varying sentiments.

Passive RDs, on the other hand, tend to have more predictable risks because large or significant changes in portfolio management are rare.

Transparency of Investment Decisions

The final difference between active and passive mutual funds can be seen in the transparency of investment decisions made by the Investment Manager. In active mutual funds, the Investment Manager's investment decisions are arguably less transparent. This is because decisions to change the investment portfolio in this type of mutual fund can be made quickly to adjust the Investment Manager's strategy and analysis.

In contrast, in passive mutual funds, investment decisions are more transparent and easier for investors to monitor. This is because portfolio management follows the composition of the benchmark index, which is generally open to the public.

So, Should You Invest in Active or Passive Mutual Funds?

After understanding the explanation of active and passive mutual funds, you should have an idea of which product is better suited to your needs and investment goals. If you are looking for high potential returns and are willing to take risks, active mutual funds are ideally the more appropriate choice. Conversely, passive mutual funds tend to be more suitable for investors who prioritize consistent performance, lower risk, and the absence of higher transaction costs.