Why you should avoid active mutual funds

The biggest reason I recommend against actively managed mutual funds is that most investors have a time horizon much longer than any AMC’s or the fund manager’s.

Assuming you start investing when you’re 40 and you live up to 80, your retirement portfolio has a lifespan of 40 years. Quite a few people will have portfolios with a longer time frame. Many would start investing at a younger age; many would want the retirement corpus to last for an additional decade or more. A lifespan of 50 or 60 years for a retirement corpus is not unusual.

It’s fairly easy to shortlist active funds that are great today. There’s a reasonable chance that these funds will stay good for the next 10 or 20 years. But change is inevitable. AMCs change hands; fund managers switch jobs; fund managers retire; investing landscape changes; regulations change. In a constantly changing world, it’s impossible to tell which of today’s top active funds will remain good 30, 40, 50 years from now.

A passively managed portfolio will never give you amazing, market beating returns, but the characteristics of such a portfolio won’t dramatically change later on. Anyone that likes a predictable portfolio over an unpredictable one should seriously consider passive management. (This is predictability relative to the market. A passive portfolio that replicates the market will always have the same amount of risk and return as the market itself. The risk and return of active portfolios can drift in either direction.)

While that’s my stance in general, I still use and recommend some actively managed funds. They are often hybrid or multi-asset funds that can act like “one fund portfolios” (meaning that’s the only fund you have in the entire portfolio).

• I use such funds to hold cash for a short duration (such as a few years). 
• I also recommend such funds to people who wouldn’t get any equity exposure otherwise. The chosen active fund may not be the best available, but if it’ll generate more return than a bank deposit. That’s often good enough.