Passively managed funds
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.
How passive management works
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
- Trades within the portfolio are automated, with little or no human decision-making involved.
- It’s a simple and straightforward investing approach that makes these funds a popular choice for some investors.
- Expense ratios1 of actively managed funds, which require ongoing analysis and portfolio management, are typically higher than passively managed funds.
Costs and fees of active versus 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.