Short answer: Passive investing means holding a portfolio designed to match the performance of a broad market index, rather than trying to beat the market through stock selection or timing. Its core goal is to earn roughly market-level returns while keeping costs as low as possible.
Last reviewed: 6 November 2026
At a glance
| Term | What it means |
|---|---|
| Passive investing | Holding a portfolio designed to match a broad market index’s performance |
| Active investing | Trying to outperform the market through stock selection or timing |
| Index fund and ETF | The main vehicles for passive investing; an ETF (exchange-traded fund) is a fund that trades on a stock exchange |
| Buy-and-hold | Staying invested for the long term without frequent buying and selling |
| Expense ratio | The yearly fee a fund charges, expressed as a percentage of the money it manages |
How does a passive fund work?
A passive fund starts with an index, which is a list of companies chosen by fixed rules to represent a part of the market. The fund then holds the same companies, in roughly the same proportions, as the index. When the index rises or falls, the fund’s value moves in step with it.
Passive investing is mainly carried out through index funds and exchange-traded funds. An ETF following an exchange index holds the index’s constituents, and its manager’s job is essentially to copy the index’s movements. The manager does not decide which companies go in, because the index’s composition is set by its rules.
Why does the index decide what the fund holds?
This is the main difference from active investing. An active fund manager researches companies, picks the ones they expect to do well, and changes holdings when they think conditions have changed. A passive fund makes none of those choices. It simply follows the rules of the index it tracks.
The result is predictable. You know which kind of market the fund is tracking, even if you cannot predict where that market will go. The fund will also hold companies whose prices have fallen, because the index still includes them.
Why does buy-and-hold matter?
Passive investors usually follow a buy-and-hold approach. They stay invested for the long term without frequent buying and selling, instead of moving money in and out as prices change.
Buy-and-hold is part of how passive investing keeps costs down. Every purchase and sale can carry trading costs, so fewer trades mean fewer costs. It also means the investor must stay through falls in the market, which is harder than it sounds.
How do costs make a difference?
Passive funds tend to have lower expense ratios than active funds, because they need less research, stock selection and trading. The expense ratio is taken from the fund’s assets each year, so a small difference in the percentage can add up over time.
Here is a hypothetical example, with invented figures for illustration only. Suppose you put ₹1 lakh into two funds, and in one year both grow by 10% before fees. Fund A charges an expense ratio of 0.2%, which is ₹200 on ₹1 lakh. Fund B charges 1.5%, which is ₹1,500. In that one year, Fund A costs ₹1,300 less in fees, and the gap grows as the amount invested grows.
What are the risks and catches?
Passive investing does not protect you from market falls. A fund that matches an index will fall when that index falls, and it will not move to cash or other holdings to avoid losses.
The buy-and-hold approach also has a catch. Staying invested through a downturn means accepting the falls along the way, and the fund’s returns will be only as good as the index it tracks. Passive investing aims for market-level returns, not above-market returns, so it will not beat the market by design.
Frequently asked questions
Is passive investing the same as index investing?
Passive investing is the broader idea of holding a portfolio designed to match a broad market index. Index funds and ETFs are the main vehicles through which it is carried out.
Who chooses the companies in a passive fund?
The index’s composition is set by rules, not by the fund manager. The manager’s job is essentially to copy the index’s movements.
Why do passive funds usually charge less?
Passive funds need less research, stock selection and trading than active funds. That generally results in lower expense ratios.
Sources and last check
Facts in this article were checked against the sources below on 6 November 2026. Rules and figures can change; check the primary source before acting.
- dhan.co (broker education)
- kotakneo.com (broker education)
- icicidirect.com (broker education)
- groww.in (broker education)
This article is general information, not investment advice. MyFinanceBandhu is not a SEBI-registered investment adviser.
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