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MUTUAL FUND FOCUS
With actively managed funds, managers decide to buy or sell securities based on their expectations for how those securities will perform.
Passively managed funds are designed to mirror the performance of an index by holding the same or similar securities in the same proportions.
Sorting through thousands of mutual funds to find the ones most appropriate for you can be a daunting challenge. Beyond the types of investments they hold, mutual funds also are categorized based on their fund manager’s investment style—active management or passive management.
In general terms, active management refers to mutual funds that are actively managed by a portfolio manager. Passive management typically refers to funds that simply mirror the composition and performance of a specific index, such as the S&P 500® Index. The S&P 500 is a market cap weighted index that represents the average performance of a group of 500 large capitalization stocks.
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With actively managed funds, managers decide to buy or sell securities based on their expectations for how those securities will perform. Typically, an actively managed fund will seek to outperform a designated index or benchmark that aligns with its investment mandate. For example, the S&P 500 Index is used as a performance benchmark for a large-cap stock fund.
Active management takes a hands-on approach. Rather than following preset rules to build a portfolio of stocks or bonds, managers of actively managed mutual funds make buy and sell decisions, selecting individual stocks and bonds according to a rigorous methodology and thorough company research.
Why active management
Often, teams of analysts and experts help identify investing opportunities, make buy and sell decisions, and manage the fund daily. These teams work to maintain the right mix of investments which they believe will achieve each fund’s specific goals for performance and risk.
Decisions are supported by financial analysis and modeling tools that help forecast possible market performance. This combination of human know-how, sophisticated tools and seasoned fund managers delivers rigor and discipline that makes active management so attractive to many investors.
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Known also as index funds—passively managed funds do not attempt to outperform a designated index. Rather, they simply seek to mirror the performance of an index by holding the same or similar securities in the same proportions. The managers only buy or sell securities as necessary to correspond with the index.
A typical passively managed fund might contain all stocks in a particular index like the S&P 500 index. When the S&P 500 index rises and falls, so does the passive fund, often by similar amounts. When individual stocks move in or out of the S&P 500 index, the fund buys and sells the same stocks. For passive funds that mirror indexes, this is sometimes referred to as “buying the market.”
Why passive management
Because of the different management styles, there may be differences in fees, costs and tax consequences. For managed funds, research and analysis costs money, which usually leads to actively managed funds having higher expense ratios than passively managed funds. And when measuring passive funds compared with an index, in the passive fund, buying and selling incurs management and other expenses, thus performance for these funds may vary from that of the index itself.
In addition, it’s important to view historical tax consequences of different strategies prior to making an investment. Both active and passively managed funds buy and sell assets, creating the potential for investors to incur capital gains taxes on their investments.
There’s no right or wrong answer to whether you should invest in active or passive mutual funds. Whatever you decide, make sure to do your research and consider all your options.
1 The expense ratio is the annual fee that a fund charges its shareholders and is expressed as the percentage of assets deducted each year for fund expenses, including management fees, operating costs, administrative fees, fees and all other asset-based costs incurred by the fund. Class S shares do not have any sales charges, loads or 12b-1 fees. Net Expense Ratio reflects any reimbursements or fees waived by the investment adviser, while Gross Expense Ratio reflects the expenses before any waivers.
Any indexes shown are unmanaged and do not reflect the typical costs of investing. Investors cannot invest directly in an index.
The information provided is not intended as a source for tax, legal or accounting advice. Please consult with a legal and/or tax professional for specific information regarding your individual situation.