Know The Difference: Active vs. Passive Portfolio Management

 When choosing to invest in mutual funds, one must ask a few key questions: do you want passive or active portfolio management? What is the difference? How will this affect returns in the future?

Active Management:

Actively managed funds seek to beat a given market index by utilizing a team of CFAs and fund managers to research and choose stocks on behalf of their clients. Leveraging additional research and the management team’s expertise can lead to a fund “generating Alpha” (earning a return and net of fees above the related index). Active managers will assess many factors, ranging from business cycles to political landscape to other macro trends, when choosing stocks worth owning or avoiding.

Of course, there is additional cost with actively managed funds. Management fees create higher net expense ratios (the soft dollar cost of owning mutual funds or ETFs) compared to passive funds, in accordance with the expectation that the active fund will outperform its index or other benchmark.

Passive Management:

Passively managed funds, on the other hand, intentionally mirror a market index. These funds, also known as index funds, are designed to hold investments that parallel the returns of a particular market index (such as the S&P 500). The management effort expended on passive funds is far less in-depth because there are fewer variables for which to account. As a result, passive funds tend to have a lower net expense ratio than active funds.

What is the right choice for you? The likeliest answer is both. Your overall planning strategy would help to inform the appropriateness of these options and in what ratio. Given the differences in fees and potential contribution to your returns, it is always recommended that you consult with an advisor to have a plan that aligns with your investment decisions.

** Investing involves risk, including loss of value, and no investing strategy can assure profit. S&P 500 is unmanaged, capitalization-weighted index of 500 stocks considered to be representative of the stock market in general. Indexes do not have sales or other charges and it is not possible to invest directly in an index

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