If you search Google for “active funds versus passive funds,” you’ll find numerous stories and reports pointing to the impending “death” of active-fund management. That’s because, for quite some time, many passive funds have consistently outperformed active funds in various asset classes.
For those who aren’t familiar, actively managed funds are so named because they have a manager (or a management team) making decisions about how to invest the fund’s money. Active funds make it possible for investors to try to beat the market (the key word being “try”), while passive funds attempt to mimic the performance of an index, like the S&P 500 or the Dow Jones Industrial Average.
Each type of fund has its advantages and disadvantages. Active funds tend to be more expensive than passive funds. To beat the market, active funds not only need to outperform their benchmark by a large enough margin to cover their higher costs. In addition, active managers tend to trade more often, leading to potential higher transaction costs or taxes that must be absorbed by investors.
Do investors really need to choose between investing in actively managed funds vs. passively managed funds?
Not necessarily. Earlier this year, a commentary by CNBC suggested that investors consider using both approaches in tandem, quoting wealth managers as saying that some categories of passive funds just aren’t very good. These articles propose that a mix of both active and passively managed funds could deliver the best of both worlds, while helping to offset each fund type’s downside.
A recent paper by American Funds encouraged argued that certain active managers, have beaten market indexes over time with reduced volatility. The key, according to American Funds, is to work closely with an advisor who uses a robust due diligence process to identify and select high-performing active managers. Then, focus on low expenses and high manager ownership.
The Bottom Line
The bottom line is, if you’re willing to do some due diligence, or work with an advisor who can help you evaluate the “active versus passive” debate in the context of your own needs and goals, you may find that a combination of the two fund types into a well-diversified portfolio could be appropriate. Remember, a fund’s past performance is no guarantee that it will continue to perform well. Also, be sure to consider your risk tolerance, your age, and your personal financial situation before determining which funds to select.
At M.J. Smith & Associates, we pride ourselves on working with our clients to create a comprehensive picture of their current financial situation and their future needs. We carefully research our recommendations and continue to monitor our clients’ investments on their behalf. If you have questions about actively and passively managed funds, or would like a second opinion on your portfolio, I encourage you to contact us for a complimentary, no-obligation consultation. We look forward to putting our knowledge and experience to work for you.
This information does not purport to be a complete description of the securities, markets, or developments referred to in this material; it has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. Investments mentioned may not be suitable for all investors. Every type of investment, including mutual funds, involves risk. Risk refers to the possibility that you may lose money (both principal and any earnings) or fail to make money on an investment. Changing market conditions can create fluctuations in the value of a mutual fund investment. In addition, there are fees and expenses associated with investing in mutual funds that do not usually occur when purchasing individual securities directly. Although passive funds are designed to provide investment results that generally correspond to the price and yield performance of their respective underlying indexes, the funds may not be able to exactly replicate the performance of the indexes because of fund expenses and other factors. Please note direct investment in any index is not possible. Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website's users and/or members.