Passively Managed Funds vs. Actively Managed Funds

In fund investment, a difference is made between actively and passively managed funds.

Actively vs. passively managed funds

When you invest in actively-managed funds, you actively participate in asset allocation. You select individual securities, regularly review performance and make changes if you so choose.

Passively-managed funds, also known as index funds, provide minimal opportunities for participation, and are primarily market-led. Passive funds like exchange-traded funds (ETFs) simply follow various market index rates.

For example, the rates of an ETF which follows the Swiss Market Index (SMI) will automatically adjust in keeping with that index. In this case the investor would be betting on the market performance of the 20 largest listed Swiss companies, as indicated by the SMI.

Can anyone outperform the market?

The dilemma: Numerous studies have shown that the vast majority of active fund managers have not been able to outperform market indexes over the long-term. Future stock market developments are too complex and unpredictable to forecast accurately. Over the long term, investing in passively-managed funds which simply invest in the assets which underly market indices often brings higher returns than using actively-managed investment products.

Notable Cost Differences

Another factor is that actively-managed funds are typically more expensive than passively-managed funds. Although the costs of actively-managed funds have come down somewhat in recent years, they are still notably more expensive than funds which simply track an index.

A 2020 study from ICI shows that the average total expense ratio (TER) of mutual funds with managers who actively invest capital is 0.7 percent of assets under management per year. The average TER of passively-managed stock ETFs, on the other hand, is just 0.2 percent.

Rule of thumb: passive beats active

Actively-managed funds can be a good option if you want to invest in new or specialized markets with relatively low liquidity.

Otherwise, you will almost always get higher returns from passively-managed funds like ETFs thanks to their much lower costs.

Whether you go with actively-managed or passively-managed funds, using the most affordable online broker to invest in the funds will cut the cost of investing and increase your total return.

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