Active vs. Passive Investment Management: Which Strategy Is Best for You?

by Mitchell J. Smilowitz, CPA

This article looks at the pros and cons of active and passive investing so you can determine what role these strategies should play in your portfolio.


The terms active and passive describe mutual fund management styles.

The holdings of passively managed mutual funds mirror an index, such as the S&P 500 Index, MSCI International Index or Bloomberg Barclays U.S. Aggregate Bond Index. Passively managed funds seek to generate returns equal to the index the fund mirrors.

Actively managed fund managers use research and analysis to buy and sell securities, seeking to achieve returns that surpass the index they follow.

Active Management:  Pros

  • Flexibility – Active fund managers can be opportunistic.  They can purchase investments they believe will exceed the average return of the index and limit exposure to investments the fund manager believes will underperform the index.
  • Research – Active managers allocate significant resources to analyzing economic trends, market sectors and individual companies to find the investments they feel can maximize returns.
  • Opportunistic – Active managers can use a variety of techniques intended to minimize their losses in down markets or when the managers perceive risks.

Active Management:  Cons

  • Higher expenses – Actively managed funds charge higher fees than passively managed funds because research is expensive.  In addition, active buying and selling incurs transaction costs.
  • Higher risk – When active managers are right, investment returns exceed the index; when they are wrong, returns can lag behind passively managed funds.
  • Fewer holdings – Actively managed funds may hold fewer investments than funds that mirror an index.

 What to Look for in Actively Managed Funds

  • Objectives and strategy – Look for actively managed funds with well-defined investment goals that fit your investment approach.
  • Experienced management – The funds should have a tenured team of portfolio managers and analysts who have the tools in place to yield strong performance in the long run.
  • Track record – Look for funds with good track records in both up and down markets.
  • Fees – Focus on actively managed funds with relatively low fees.

 Passive Management:  Pros

  • Lower expenses – Passive fund managers only purchase securities that mirror the index. This does not require a staff of analysts.  Because indexes change infrequently, transaction costs are lower.
  • Consistency of holdings – Passive funds only hold investments in the relevant index. The funds also seek to hold these securities in the same proportion as the index.

 Passive Management:  Cons

  • Lack of flexibility – Passive funds are limited to a specific index or predetermined set of investments with little to no variance.  This means that investors are locked into those holdings regardless of whether a sector or individual company underperforms the market.
  • Returns do not beat the index – By definition, passive funds are not designed to beat the market because their holdings mimic the index.

The Role of Active and Passive Funds in Your Portfolio

The Joint Retirement Board 403(b)(9) Retirement Plan offers both actively managed and passively managed funds. Working with an investment advisor, the JRB’s Investment Review Committee rigorously reviews fund offerings following both strategies. The selection and monitoring of the actively managed funds follows the suggestions noted: we look for funds with specific investment objectives, experienced management, a good track record and low fees. The index fund offerings are managed by well-known investment companies and cover the major assets classes: a fixed income index; a large company index; a mid- and small company index; and, an international index.

The most important investment decision you make is deciding on a mix of stocks, bonds and cash that is appropriate for your goals, investment timeline and risk tolerance, not whether you choose actively or passively managed funds.

Once you choose an appropriate mix of investments for your portfolio, take a long-term perspective.  Be disciplined. Don’t make emotional decisions based on short-term ups and downs of the market. 

Balance the expenses charged by actively managed funds against the value which fund managers bring to the selection of securities and potential achievement of higher overall returns. 

But the key insight for many investors is that you don’t need to choose between index approaches and active strategies—it doesn't have to be all one or the other. By mixing actively managed funds with passive index approaches, you can customize your portfolio to meet your investment goals.


December 2017