How To Select Funds To Achieve Different Goals

There has always been a debate as to whether investors should prefer passive funds or active funds. 

The discussion over this issue often leads to passionate arguments, and while this might make for an interesting conversation, an investor need not look at the entire issue in a binary fashion. They need to put their choices into proper perspective and then make a decision as to what is suitable for their requirements.

Here is how they can look at the issue in an alternative way:

The first thing that an investor has to understand is that choosing one category of fund for inclusion in the portfolio need not always be at the exclusion of the other.

There should not be the perception that a specific type of fund is being selected over another category, though in some cases this might happen. In the process of portfolio creation, one might include both active and passive funds in order to achieve the desired goals. It is easy to get swayed by the arguments about the effectiveness of a specific category of funds, but the reality is that there is so much variety present in terms of choices that different uses can have varied options.

The investor would actually end up harming themselves if they shut themselves out of one whole category of funds, so they should not consider these to be mutually exclusive.

One way to decide between a passive fund and an active fund is to look at the goals to be achieved. This can provide a clear road map in terms of what needs to be included because there might be specific goals that require a certain approach.

For example, some goals might require an aggressive approach, which might be met with mid- and small-cap funds, and here the investor might prefer to go with active funds for the purpose of generating alpha. The reverse might be true for some other goal, and as such, the approach would change.

As long as the goals are kept at the centre of the planning process, then the selection decision will be easier to make.

There is also the question of how much time you are able to devote to the entire process of selecting the funds.

This is important because it will lead you to look at active funds if you have enough time and knowledge to look through the different funds in different categories and then choose one that fits your needs. On the other hand, there are people who do not have the time to do this at all. At the same time, they are also not willing to engage the services of financial planners to advise them, either because of the cost involved or because they might not see value in this move. This would put them in a situation where the passive category would be a right fit because the returns here would track the index, and hence there is ease of effort involved with little risk of underperformance.

The final part of the process is the understanding that is essential when one is selecting either type of fund.

There has to be proper knowledge of both the categories of funds and how they operate because, within each category, there are multiple choices. This will help in understanding the final outcome in an easy manner.

For example, taking a passive fund and then expecting it to outperform the market is the wrong expectation, which will not be achieved. Similarly, for active funds, expecting something to do well in all market conditions is also not a realistic expectation. This kind of understanding will go a long way towards ensuring that there is a proper selection made, and it might result in the usage of both types of funds in the portfolio.

Arnav Pandya is the founder of Moneyeduschool.

The views expressed here are those of the author, and do not necessarily represent those of BQ Prime or its editorial team.