Why passive investors should avoid making the same mistakes as active investors

Published: March 27, 2021 at 6:22 pm

Last Updated on March 27, 2021 at 8:46 pm

Interest in passive investing has increased in India over the last few years. This trend was driven by perceptible outperformance: first was the increase in interest in Nifty Next 50 – as usual after the index started moving south in 2018. Then in the Nifty and Sensex as they were held up by a few stocks while the rest of the market suffered. In this article, I discuss why passive investors should avoid making the same mistakes as active investors.

Before we begin, we must understand that active funds’ underperformance is not a “recent phenomenon” in India. We have already established that Active mutual funds have struggled to beat Nifty 50 for the last seven years! Also, see: Poor performance of active mutual funds: Is this a recent development?

Just that after Feb 2018, the opportunities in the bottom half of Nifty 50 and Nifty 100 visibility dried up, and index funds shot up to the top of the returns table, and the return difference of Nifty 50 vs Nifty 50 Equal-weight index was at an all-time high in Dec 2019. It took the March 2020 crash to reset it.

We have crunched enough data. In this article, I would like to discuss the mindset of active and passive investors. It is not necessary to take an extreme stance to justify one’s choices. In fact, it is not necessary to justify it at all!

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥

Allow me to explain. The justifications provided for choosing active funds are well known: “Indian is not a developed market like the US; finding alpha is not as difficult; there are opportunities in the mid and smallcap segments”, etc.

Sadly, some of the justifications for choosing passive funds are just as extreme: “if you choose passive funds, you are sure to beat most active funds over the long term”.

Yes, this is already a fact we saw for US mutual funds: Only 582 out of 3474 US Large-cap funds outperformed S&P 500 over the last 10 years. And it could well be a fact for Indian MFs in future too (it currently about 50:50, which is just as bad – links within the above article).

However, “believing this” when starting with passive funds is no different from expecting 15% returns from a “long-term SIP” or assuming “alpha is definitely possible in the Indian market”.

There will always be some funds that beat the market – today or tomorrow. Only an investor who recognises the impossibility of selecting future winners today should get into passive funds. Otherwise, the moment they see a few funds outperform, the “fear of missing out” will take over. See for example: After the market crash, 80% of active large-cap funds outperform Nifty, Nifty 100.

It should be irrelevant for the wannabe passive investor, whether 25% or 50% or 85% of active funds underperform the market today or tomorrow. Nothing changes the fact that a future outperformer cannot be identified today and active investing means fund-hopping based on past data. Everyone likes extra returns, but the true passive investor appreciates the true cost of the search for alpha.

Unless a passive investor accepts this reality, the interest in passive funds will wane as quickly as it started. The passive investing gang tend to have a holier-than-thou attitude and make it sound as if only the alpha-seekers are subject to cognitive biases. Well, sample this:

  • I am invested in a Sensex fund, but everyone is talking about only NSE indices. Am I missing out on anything?
  • Which is the best index fund to start a SIP?
  • Can I invest in more of Nifty Next 50 for more returns?
  • ABC is coming out with the ABC nanocap index fund. I am already holding four index funds; Should I consider this NFO to cover the nanocap segment?

Fact-based investing must determine our choices, but what makes us stay the course is what we believe in. A feeling of superiority in our investment beliefs and choices is both unnecessary and harmful.

Check out our new debt mutual fund screener for selection, tracking and learning (March 2021)

Do share this article with your friends using the buttons below.

🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! More than 1,000 investors and advisors use this!
New Tool! => 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.
Follow Freefincal on Google News
Follow Freefincal on Google News
Subscribe to the freefincal Youtube Channel. Subscribe button courtesy: Vecteezy.
Subscribe to the freefincal Youtube Channel.
Follow freefincal on WhatsApp Channel
Follow freefincal on WhatsApp
Podcast: Let's Get RICH With PATTU! Every single Indian CAN grow their wealth! 
Listen to the Lets Get Rich with Pattu Podcast
Listen to the Let's Get Rich with Pattu Podcast
You can watch podcast episodes on the OfSpin Media Friends YouTube Channel.
Lets Get RICH With PATTU podcast on YouTube
Let's Get RICH With PATTU podcast on YouTube.
🔥Now Watch Let's Get Rich With Pattu தமிழில் (in Tamil)! 🔥
  • 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 over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!

About The Author

Pattabiraman editor freefincalDr 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!
Both boy and girl version covers of Chinchu gets a superpower
Both the boy and girl-version covers of "Chinchu Gets a superpower".
Most investor problems can be traced to a lack of informed decision-making. We made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, what would it be if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life? My answer: Sound Decision Making. So, in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parents plan for it, as well as teaching him several key ideas of decision-making and money management, is the narrative. What readers say!
Feedback from a young reader after reading Chinchu gets a Superpower (small version)
Feedback from a young reader after reading Chinchu gets a Superpower!
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
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished 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 Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis 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

Travel-Training-Kit-Cover-new 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)