Actively managed funds

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.

How active management works

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

• When you invest in these funds, you’re benefiting from the years of experience across a wide range of market conditions that fund managers provide.
• Investors who prefer funds with active management believe this more human approach provides a real financial value that passively buying the market (or a segment of the market) based on an automated model, cannot.
• Active fund managers have a host of resources to help them track and respond to the market’s ups and downs as well as positive or negative changes to individual company’s fundamentals.
• When you invest in an actively managed fund, you’re tapping into the collective expertise of the fund managers and their teams who understand the factors that can impact individual companies and the market as a whole.

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.

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.