If you've ever wondered what the difference is between an active and passive investment fund, know that one may be a better fit for your investing needs than the other. An actively managed investment fund is one in which a manager or a management team invests the fund's money. In contrast, a passively managed fund tracks a market index. It lacks a management team to make investment decisions. The term "actively managed fund" is commonly used to refer to a mutual fund, but there are also actively managed ETFs (exchange-traded funds). The fund type alone should not be used to determine whether you have an active or managed fund. You can find one or the other in a variety of categories, so read the prospectus of any fund you're interested in to learn more.
Main Points
- Both types of funds have their advantages and disadvantages, and investors must decide which is best for them.
- Actively managed funds have a better chance of outperforming the market. Still, they usually charge a higher fee, and many of them fail to outperform the market on a consistent basis.
- Although passively managed funds are less expensive and have a better track record, your performance is still average.
The Benefits and Drawbacks of Each
The debate over whether actively managed or passively managed funds are better is popular in the personal finance community. Actively managed funds have the following advantages, according to their supporters:- Active funds allow you to outperform the market index.
- Several funds have been known to generate massive returns, but because each fund's performance varies over time, it's critical to read the fund's history before investing.
Actively managed funds, on the other hand, have several drawbacks:
- Most actively managed funds, statistically speaking, tend to "underperform" or perform worse than the market index.
- Based on past performance, we can't predict how well a particular fund will perform. In reality, there is no way to predict how well a fund will perform over time.
- Taxes and fees are incurred every time an active fund sells a holding, lowering the fund's performance.
- You'll pay a flat fee regardless of how well or poorly your fund performs. If the index provides a 7% return and your active fund provides an 8% return but charges a 1.5 percent fee, you've lost money. 5% of the total
Actively and Passively Managed Funds Examples
Passive: Bob invests in a passive fund that tracks the S&P 500 Index. His fund is an index fund that is managed passively. He pays a management fee of 0.06 percent. Bob's fund is guaranteed to match the S&P 500's performance. Bob knew his money did about the same thing as the S& P when he turned on the news and heard the anchor say the S&P rose 4% today. When he hears that the S&P has dropped 5%, he knows that his money has also dropped 5%. Bob also understands that his management fee is insignificant and will have little impact on his profits. Because it's nearly impossible to track something perfectly, Bob understands that there will be minor differences between his fund's performance and the S&P 500. However, those minor differences will be insignificant, and Bob's portfolio will closely resemble the S&P 500. Active: Sheila's money is invested in a mutual fund that is actively managed. She is charged a management fee of 0.95 percent. Sheila's actively managed fund invests in a wide range of securities, including banking, real estate, energy, and auto manufacturing. Her fund managers conduct industry and company research and base their buy and sell decisions on projections of their performance metrics. Sheila is well aware that she is paying nearly 1% to those fund managers, which is significantly more than Bob. She's also aware that her fund will not follow the SP 500. According to a news anchor, Sheila can't draw any conclusions about her money because the SP 500 rose 2% today. Her account could have increased or decreased in value. Sheila likes this fund because it allows her to pursue her dream of outperforming the market index. Bob is a firm believer in the index, and his fund's performance is based on it. On the other hand, Sheila has a chance of outperforming (or outperforming) the index. After going over these examples, you'll have a better idea of how the two funds work in practice, and you'll be able to decide which one is best for you.Most Commonly Asked Questions (FAQs)
How many actively managed funds outperform the market?
SPIVA, a division of S&P Global, examines actively managed fund performance compared to the overall market regularly. Just under 42% of actively managed large-cap U.S. funds outperformed the market in the last year. That percentage has dropped to around 17.5 percent in the last ten years.When actively managed funds don't outperform the market, what happens?
In other words, when actively managed funds fail to outperform the market, nothing happens. When buying actively managed fund shares, investors are not guaranteed a certain level of performance. If an investor is dissatisfied with a fund's performance, their only option is to sell their shares in the fund.Which Vanguard Bond funds are managed actively?
Vanguard offers more than 30 actively managed fixed-income funds. They include both general funds such as the Core Bond Fund (VCOBX) and more focused funds such as the Pennsylvania Long-Term Tax-Exempt Fund (VPALX).Why do low-fee passively managed funds have such a low fee structure?
There are fewer choices to be made and trades to be made. Passive funds also necessitate less overall effort. The majority of passively managed fund operations can be automated, leaving the fund manager with only the task of overseeing and resolving any issues that arise. This is a lot less expensive than hiring experts to help you decide when and what to buy or sell.