Active vs index funds: Which strategy protects your investments better?
Investing in the stock market can be both rewarding and challenging. Investors often face the dilemma of choosing between active funds and index funds. While index funds offer simplicity and low fees, active funds provide a dynamic approach that can be particularly advantageous during market corrections.
This article explores how the active management strategy can shield investors from sharp market downturns, which is inherently difficult for index funds to achieve.
Active funds are managed by professional fund managers who make decisions based on research, market conditions and forecasts. They aim to outperform the market by selecting stocks that are expected to perform better than average. Most importantly, active funds can adjust holdings based on market conditions. As against this, index funds are passively managed and designed to replicate the performance of a specific index (for example S&P BSE 500 or Nifty 50). They hold a fixed portfolio of stocks as per the index composition. Low cost and simplicity are major advantages of passive funds, but they lack flexibility.
Tactical asset allocation: Active fund managers have the discretion to alter the fund’s asset allocation. During signs of an impending market correction, they can reduce exposure to equities and increase holdings in more stable assets such as bonds or cash. This tactical shift can mitigate losses when the market takes a downturn.
Example: During the 2008 financial crisis, some active fund managers significantly reduced their exposure to financial stocks and moved into more defensive sectors such as consumer staples and healthcare, thereby reducing the impact of the sharp market decline.
Stock selection and sector rotation: Active fund managers can
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