Last Updated on July 10, 2021 at 8:15 am
Let us discuss a question from a reader who prefers anonymity: “Is it ok to invest in 50% index funds (passive funds) and 50% active funds for the equity portfolio in my retirement portfolio?” The answer depends on what the motives behind such an allocation are. This discussion applies to any mix of active funds and passive funds.
If investors wish to have a “bit of this” and a “bit of that” approach “just in case”, then I am afraid it is just clutter. That is, they are on the fence wrt the active vs passive debate, unsure which will do better in future, so assume it is better to go halfsies! Adding more funds could make the entire equity portfolio track the “market” at a higher cost than a passive portfolio.
Passive investing needs conviction. Not the fanatic belief that their choice is the best but the confidence and the maturity that active fund performance will fluctuate; some will beat the market and some will not; that It can be pretty tiresome over the long run to keep chasing these winners and is far simpler to choose passive funds. After all, if an active fund produces inflation-beating returns, then so will a passive fund, so might as well save on the management fees.
Unless an investor has this conviction, this clarity, this maturity, they can never find happiness with passive investing, whether it is 100% of their portfolio or 10%. So if this 50:50 business is more due to a fear of missing out (on either option), it is likely to meet a sticky end.
Join 32,000+ readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email! (Link takes you to our email sign-up form)
🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥
Sure there is nothing terribly wrong with a 50:50 mix of active and passive funds in the same way as there is nothing wrong with holding 25 equity mutual funds in a portfolio. If this is you – “I am confused, I am not entirely sure which choice is better. so I want a mixture of the two”, then go ahead. Just do not assume or claim that this is better than 100% active or 100% passive – only time will decide that!
Amusingly after starting this article, I was shown an excerpt from a new mutual fund book (better left unnamed) which seems to be sponsored by AMCs. It recommends a small passive allocation (against best left unmentioned). Why? To benefit from this if that does not work and from that if this does not work.
What is amusing is, AMCs seems to want the best of both worlds: AUM from active and passive. They have recognised the increase in passive AUM in recent months and wish to fan the flame further. A business can afford to aimlessly clutter its portfolio with all sorts of NFOs, investors need to think twice.
Having interacted with investors for the last nine years, I can say with confidence and certainty that most investors neither have the ability and, more importantly, the courage to assess how well any mix of active + passive funds (including 0% of either) will do after they start investing.
Before we move ahead, let me reiterate: a mix (any mix) is ‘ok’ as long as you have the more important aspects of investing in place: the right inflation and portfolio return expectations, a reasonable asset allocation and de-risking strategy and most importantly a plan to keep investing more and more in the years to come. Sadly those who have a problem deciding which scattergun to buy often also have a problem in getting their “basics right”.
If your portfolio is small since you have just started investing, then it would better for you to choose passive funds and focus on more important aspects such as goal-based risk management and increasing your income and, therefore, investments in the future.
If you have been investing for a few years and wish to gradually increase allocation to passive funds without redeeming or switching from active funds, it is fine as long as passive funds become dominant in the next few years. You could then redeem from the active funds as and when you need to rebalance from equity to fixed income.
You could also gradually switch from active funds to passive (if you want to!) if your equity allocation is small (regardless of the number of years you have been investing) and if one or more funds are in “red” (loss). Then the switch will not cost you any tax.
The situation for older and heavier portfolios is a bit more tricky. Regular readers would be aware of the funds I hold, and they are all active. Suppose I stop further investments in them and invest all my future investments (meant for equity) into a passive fund and increase this investment at 10% a year; it would take more than 22 years for the index fund allocation to overtake my largest active fund. I have assumed the index fund grows at 10% CAGR and the active fund at 8% CAGR.
So adding an index fund to my portfolio would only clutter it up. I will have to make a huge switch to an index fund to be a meaningful passive investor. I see no point in paying tax to do that. I also see no point in fixing something that is not broken. The only consideration before me is the tax I would pay on switching more or less than the amount I would “lose” on fees in future? I do not know the answer to this. In any case, my frugal side will never permit me to pay taxes on something that seems unnecessary.
I am happy with my funds and believe that the power of inertia or doing nothing unless necessary is key to investing success. And IMO a change is neither meaningful nor necessary to my portfolio. Please do not misconstrue this as some attempt to get more returns. I have graduated from that stage, thankfully.
Fund management fees are certainly an important consideration but not the most important consideration. Investors should adopt a process-first, products-last approach. The process (clear goal target, variable asset allocation plan, review/rebalancing) has to be in place first, and this would naturally lead us to the right product categories. What we choose from these categories is largely a matter of personal choice. Just that we should not assume there is an ideal choice and our choice is the best. It usually never is, as it rarely gets validated.
🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 7000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! ⇐ More than 2,500 investors and advisors use this!
Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
- Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
- Have a question? Subscribe to our newsletter using the form below.
- Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.
Join 32,000+ readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email! (Link takes you to our email sign-up form)
About The Author
Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course! Increase your income by getting people to pay for your skills! ⇐ More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
- Twitter @freefincal
- Subscribe to our YouTube Videos
- Posts feed via Feedburner.
Our publications
You Can Be Rich Too with Goal-Based Investing
Published by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
This book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.Your Ultimate Guide to Travel
This is an in-depth dive into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)