When you invest in a fund, you’ve got two basic options: You can have it actively or passively managed. In general, passive investing is more of a buy-and-hold approach, while active investing is more proactive, with frequent buys and sells in an attempt to achieve quicker profits.
There was a time when actively managed funds—which can include a mix of stocks, bonds or other assets (from commodities like oil to real estate)—were the norm. Over the last decade, though, investors have been moving billions out of active funds and into passive ones. By the end of 2016, investors had about $5.3 billion invested in passive funds versus $9.6 billion in active funds.
It means a fund is managed by fund managers or brokers, who buy and sell in an effort to outperform an index. Active managers of stock funds, for example, buy and sell shares to try and beat an index like the S&P 500. They rely on information about market trends, economic shifts, political changes and other factors that may affect companies’ earnings to make decisions.
With that information, they try to time purchases or sales of investments to take advantage of fluctuations in the market. (Of course, you can try to do the same yourself, but this exercise is tough enough for the pros.)
Investors who opt for active management are usually looking for short-term profits instead of long-term growth. While active investment managers may say they can provide investors with returns that are greater than standard market growth, their active management and frequent trades result in higher fees for investors, which may cancel out any increased returns.
Don’t mistake “passive” for “inactive.” When an investment fund or portfolio is passively managed, that just means it’s allocated and maintained in a way that matches a specific index like the S&P 500. By weighting the portfolio or fund to match the index, managers expect it to yield matching returns.
While passive investing isn’t intended to outperform the market, it can yield high returns over time. And since the strategy isn’t proactive, management fees are usually far less.
Fees are an issue, since they can wipe out gains, but more investors have probably been turned off by the fact that the vast majority of actively managed stock funds have failed to outperform the benchmark indexes over the last decade, according to an analysis by S&P Dow Jones Indices.
In other words, if you’d put money into an index fund and left it there, you probably would have done better than most people who put money into actively managed funds. And you probably paid less in fees, too.
Another factor is the growing popularity of passively managed exchange-traded funds (ETFs), relatively low-cost stock, bond or commodity funds that are traded like stocks but often track an index. Investors had a record $3.45 trillion invested in ETFs in November, according to research firm ETFGI. And there are now thousands of different ETFs to choose from.
In this case, it usually does. Some actively managed funds outperform the indexes, but ETFs, index funds and other passively managed funds allow you to get into the market for low fees, then sit back and watch your investments grow with the market over time.
Investors who try to predict where the market will go often end up buying and selling at the wrong times and losing money, says Ben Barzideh, wealth advisor at Piershale Financial Group in Crystal Lake, Ill.
“The vast majority of people who try to time the market will not be able to do it effectively,” he says. “They’ll usually underperform a typical investor who diversifies a portfolio and just sits on the positions and rides out market ups and downs.”