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The logic of passive investing, the long-run effect of the expense ratio, and the place for active
Published by The Retail Trader · AUG 09, 2026 · Features
One fund copies the index. In another, a manager picks stocks and tries to beat the index. Both have their own arguments, and the real difference between them comes down to cost.
It simply holds the index's stocks in the same weights. No selection, no view. That is why its cost is low.
Its return is roughly that of the index, minus its cost and a small tracking difference. It will never get far ahead of the index — and it will not fall far behind either.
The whole argument for an active fund is that a manager can pick better than the index. That does happen — but to do it the manager also has to clear their own extra cost.
This is where the maths gets tough. If the fund's cost is high, the manager has to do not just better than the index but considerably better, so that a difference is left in the investor's hands.
A small percentage becomes big over a long time:
• The annual cost is charged on your entire corpus, not just on the profit.
• That cost compounds too — the money that went into fees can never earn anything afterwards.
• So the difference between 1% and 0.2% becomes a big number over ten to fifteen years, even if the returns remain almost the same.
• The difference between a direct plan and a regular plan sits here too — it is the difference of distributor commission, and it is charged every year.
The less research there is on a segment, the more room there is for a good manager. This is why the debate is different in large caps and different in smaller companies.
The other place is risk management — some active funds fall less than the index in a decline, and for many investors that is the real benefit, more than the return.
Last year's return is the least useful number. The more useful things are: a long track record, the same manager being in place for a long time, the cost, and how the fund behaves in bad periods.
And most important — the fund's own mandate. A fund that is making returns by going outside its mandate quietly changes the balance of your portfolio.
This article is for educational purposes only — it is not a buy or sell recommendation, makes no claim of guaranteed returns, and is not advisory. Rules, rates and mechanics are changed from time to time by the exchanges, SEBI and RBI, so verify every number yourself with your broker or an official source.