Active vs Passive Mutual Funds

Passive mutual funds are often called index funds. These funds try to mimic a certain index by investing in exactly the same securities and in the same proportion. It is called passive because no one is making decisions on what or what not to invest in. They simply try to mimic a certain stock or bond index. An example would be a S&P 500 stock index fund which would simply buy all the companies in the S&P 500.

A passive mutual fund has two advantages over a active mutual funds. One being that a passive fund is much cheaper to run which usually equates to lower expenses that you have to pay. A passive fund is not actively managed by tons of analysts with big salaries. They also tend to be more tax efficient.

The second advantage is that passive funds, on average, perform better than active funds. Of course history does not always repeat itself, but your odds of beating the market usually go up when investing in a passive fund.

On the other hand, an active mutual fund will have the advantages of expert analysis since it is actively run by an experience fund manager.

An active fund will also give you the chance of higher returns. A passive fund mimics an index so your return will be similar to that of the index. An active fund is aiming to beat the market by making investment decisions based on the health of the market. If a fund manager feels the market is set for a downturn he can invest accordingly. If he feels that one sector will perform better than another he can move funds accordingly.

When deciding between active vs passive mutual funds it all comes down to what you are trying to achieve. If you can afford a little more risk in attempt to beat the market than you can choose an active fund. If you are looking for lower fees and a more tax efficient investment than you can choose a passive fund.

It is worth noting that around 80% of mutual funds fail to beat the market each year.

Mutual Funds FAQ