Since there is a wide range of mutual fund products available, first time investors might find it difficult in deciding which schemes to invest in. While most mutual fund investors only understand mutual funds as equity and debt, there are several other sub-categories as well like, ELSS, gold, ETF, etc. Also, mutual funds can broadly be categorized as active funds and passive funds as well. Mutual funds that follow an active investment strategy where the fund is actively managed by a team of fund managers, market researchers, and analysts who evaluate credible stocks to build an actively managed portfolio of securities are referred to as active mutual funds. On the other hand, mutual funds that follow a passive investment strategy where the fund manager has very little say in terms of how the fund performs are referred to as passively managed funds.
An index fund and a mid cap fund are two such mutual fund schemes that follow the passive investment strategy and active investment strategy respectively. Let us find out the difference between these two and learn which one is ideal for your financial goal.
What is an index fund?
An index fund is an open ended mutual fund scheme that tracks the performance of its underlying index to generate capital appreciation. Of its total assets, an index fund must invest at least 95 percent in equity and equity related instruments of its underlying benchmark. This fund invests in stocks belonging to a particular index and does not invest in stocks listed on any other index. While other mutual funds aim at outperforming their underlying benchmark, index funds try to generate returns in tandem with the index or benchmark they’re tracking with minimum tracking error.
What is a mid cap fund?
Mid cap funds are equity schemes that invest in stocks of companies with medium market capitalization. These companies predominantly invest in companies that are listed between 101 to 250 in terms of market capitalization. SEBI mandates mid cap funds to invest a minimum of 65 percent of its total assets in mid cap company stocks. These funds may generate returns better than large cap funds but not might be able to generate returns more than small cap funds. However, no mutual fund schemes guarantee returns and returns vary depending on the underlying securities of the portfolio perform from time to time.
Should you invest in mid cap funds or index funds?
Before concluding whether you must invest in index funds or mid cap funds, do understand that you should never depend on just one investment for all your financial goals. It is essential to keep a well-diversified investment portfolio so that you mitigate your overall investment risk. Both mid cap fund and index fund have their own pros and cons. We’ll discuss each of these two funds basis which investors may be able to decide which one is ideal for their financial goals.
Mid cap funds invest across the mid cap market. The fund manager may invest the remaining of the portfolio in fixed income securities or try to capitalize on the market segments i.e., large cap and small cap. These funds invest in stocks of companies that are putting in all their efforts to become large cap companies. Mid cap companies invest in equity markets and try to generate capital appreciation over the long term.
Index funds are passive funds where the scheme tries to generate returns by tracking the performance of the underlying securities of their benchmark. Since these are passive funds, they have a low expense ratio which is good in the long run as investors will only end up paying a small portion of their capital gains to the AMC.
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