Active versus passive investing – How to make a choice in 2026

29 Jan 2026 , 01:15 PM

WHY PASSIVE INVESTING IS GATHERING PACE?

Passive investing was hardly talked about till the pandemic. Post the pandemic, there was a rapid spike in the total passive assets under management. If you look at the mutual funds today, nearly 17-18% of the total assets under management of over ₹80 Trillion are passive assets. These include passive equity assets, passive debt assts, gold ETFs, silver ETFs, global ETFs etc. The interest in passive assets has risen for various reasons.

Firstly, they are simple. Instead of buying specific stocks, you just buy the entire index. As Jack Bogle of Vanguard said, “Why look for a needle in a haystack, when you can buy the entire haystack.” Passive investing is about buying the haystack using the index or commodity as a proxy. Secondly, active funds were struggling to beat the market index, which really did not make sense to investors. Above all, passive funds and ETFs are a lot cheaper in terms of the total expense ratio (TER), adding to value creation.

ACTIVE INVESTING VERSUS PASSIVE INVESTING

Let us understand the essential difference between active investing and passive investing and why this distinction is important. In active investing, the individual investor or the fund manager actively manages the portfolio by deciding which stocks to buy and which stocks to sell. Active investing can be managed in two ways. The investor can directly create a portfolio of equities using their trading and demat account.

Secondly, they can also opt for an active mutual fund, wherein the fund manager makes the buy and sell decisions and passes on the benefits of diversification to the investor. One of the big advantages of active investing is that it enables generation of alpha (excess returns), while a passive strategy only matches a commodity or an index and does not beat it. Hence, passive has no alpha. However, active investing is vulnerable to investment decision errors.

Passive investing is about selecting the benchmark to track. For example,  if you want to buy large cap stocks, you can buy a Nifty ETF. Alternatively, if you want to create a portfolio of mid-cap stocks, then you can buy a Mid-Cap index ETF. You can also have passive allocation to gold and silver through gold ETFs and silver ETFs. How do ETFs differ from a passive mutual fund?

ETFs are listed and need a trading account and demat account to transact. Index Funds are not necessarily traded, and you can buy or redeem such index funds with the AMC. Also, index ETFs represent a fractional share unit and also entail brokerage and demat charges, apart from the TER. Index funds only entail TER, and participate in the index portfolio.

To sum up, in passive investing, the focus is on the broad theme and then the investor decides to just track an index rather than beat the index. In India, index investing has worked quite effectively in the last few years. The lower costs make it more attractive. Let us now turn to factors influencing the decision of active versus passive investing.

1)    SIZE OF YOUR PORTFOLIO IS A KEY FACTOR

If you have a large portfolio by value, it makes sense to look at a serious active strategy. You can have the time and bandwidth to invest in making such decisions. Also, with a larger portfolio, it is possible to get a diversified mix of assets which manages risk better. On the other hand, if you are just starting off or if your portfolio is very small, then you can achieve most of your goals through a passive fund itself. It saves the hassles, and is also simpler.

What are the examples of active investing. Buying stocks directly into your demat account is an example of active investing. Active investing can also be done by investing in an active fund like a large cap fund, mid-cap fund, or sector fund. Here, the fund manager makes the key decisions and ensures you get a diversified portfolio. Passive investing is lower on cost and includes index funds, index, ETFs, gold ETFs, gold funds etc.

2)    HISTORICAL PERFORMANCE OF VARIOUS FUNDS

One way to take a call is based on the past performance. Recent studies have shown that typically more than 70% of the active funds struggle to outperform the indices. So, you run the risk of bad performance and also not selecting the successful 30%. If you feel that the historical performance of passive funds (after costs) is close to that of active funds, then passive funds make a lot more sense. After all,  they are low-cost and you do not have to worry about fund selection. While past performance may not be reflective of the future, category leaders tend to be consistent over time.

3)    PASSIVE FUNDS ARE MORE COST CONSCIOUS

One of the biggest advantages of passive investing is that the costs are sharply lower. For example, for an average large cap fund, the total expense ratio (TER) would be around 2.5% all inclusive. The same cost for an ETF would be closer to 0.7%, including the brokerage and the demat charges. Clearly, this proves to be economical. So, unless the active fund is able to beat the index ETF by more than a margin of 250-300 bps, active investing really does not add much value to the investor.

There was an interesting story about passive investing in the annual note to shareholders by Warren Buffett in 2016. He had lauded John Bogle of Vanguard who had saved billions of dollars in costs to American households by offering his passive index funds and index ETFs. That is where passive investing scores. With return advantage becoming finer, there is an automatic shift towards passive investing.

4)    CONTROL OVER THE PORTFOLIO FAVORS ACTIVE INVESTING

One of the arguments against active investing is that it does not give the investor or the fund manager full control over the portfolio mix. That is true. In a passive portfolio, your performance is not assessed by whether you outperform the index. Instead, you are evaluated based on how well you mirror the index with minimal tracking error. In return for simplicity and lower costs, you do cede control over portfolio mix in passive investing.

For HNIs and ultra HNIs, the natural preference is towards a stock portfolio that is customized to special situations, news flows, their unique choices etc. It is not just about performance, but they are willing to take a much longer view of the portfolio as long as they have better control. In such cases, active works better. Today, passive funds also come with smart beta variants, but that is not passive in the strict sense of the term.

5)    HOW WELL CAN THE PORTFOLIO BE DIVERSIFIED?

This is a key consideration in any investment plan. Diversification is about spreading the asset mix across different classes. By opting for assets with negative to low correlation, the portfolio is better protected in a stress scenario. In an index fund, that diversification is automatically achieved since the index by default is diversified. We are talking about generic indices and not about sectoral or thematic indices.

At a macro level, passive approach works better to diversify investments. However, when we are looking at a multi-asset approach, active is a better choice. For example, if you are looking at a combination of equity, debt,  arbitrage, money markets, gold, silver, and REITs, then there is no single index or combination of indices that can be a good benchmark. In such cases an active allocation approach works better. Hybrid funds like Multi Asset Allocation Funds (MAAF) and Equity Savings Funds fit the bill in such cases.

KEY TAKEAWAYS FROM ACTIVE VERSUS PASSIVE DEBATE

Here are some key takeaways for investors from this debate.

• Active strategy works best when you have a larger portfolio and want more control over your investment decisions.
• Passive strategy is better for people with smaller portfolios looking for the benefit of diversification and low costs.
• In specific cases like multi-asset allocation, an active approach offers better results than a passive approach.
• Investors must opt for the strategy (active or passive) that is suited to their own unique needs.

 

LLM Summary As the name suggests, passive investing must be seen in contra-distinction from active investing. In passive investing, there is no asset selection or investment strategy applied. An index is selected and a passive fund is selected to reflect that index. The argument in favour of passive assets like index funds and index ETFs is the simplicity and their low cost. For retail investors, a saving of 1.5% a year can translate into humongous wealth creation over the long term. That is offered by passive funds. Passive fund add value because more than 70% of the active funds have traditionally struggled to beat the index meaningfully. Also, the bigger challenge for investors is to be able to identify that balance 30% that will beat the index. However, active investing still offers alpha or excess returns over the index, something you do not get in passive investing. Alpha potential and greater portfolio control are surely two arguments that favour active investing.