If you’ve ever wondered about the difference between an actively managed fund and a passively managed fund, you should understand that one may suit your investment situation better than the other.
Advantages and Disadvantages of Each Type
The personal finance community loves to debate whether actively managed funds or passively managed funds are better. Proponents of actively managed funds point to the following positive attributes:
1. Active funds provide the opportunity to outperform the market index.
2. There are several funds known for achieving significant returns, but of course, each fund’s performance can change over time, so it’s important to read the fund’s history before investing.
On the other hand, actively managed funds have several drawbacks:
1. Statistically, most actively managed funds tend to “underperform” or perform worse than the market index. We cannot know how any specific fund will perform by looking at historical data. In fact, there is no way to predict the exact performance of any fund.
2. Each time an active fund sells assets, the fund incurs taxes and fees, which reduce the fund’s performance.
3. You will pay a fixed fee regardless of whether your fund performs well or poorly. If the index provides a return of 7%, and your active fund gives you an 8% return but charges a fee of 1.5%, you have lost 0.5%.
Examples of Passively and Actively Managed Funds
Passive Fund: Bob puts his money in a fund that tracks the S&P 500 index. His fund is a passive index fund. He pays a management fee of 0.06%. Bob’s fund ensures it mimics the performance of the S&P 500 index. When Bob watches the news and the broadcaster announces that the S&P 500 is up 4% today, Bob knows that his money has done almost the same thing. Similarly, when he hears that the S&P 500 is down 5%, Bob knows his money has done almost the same thing. Bob also knows that the management fee is small and will not significantly affect his investment returns.
Active Fund: Sheila puts her money in a actively managed mutual fund. She pays a management fee of 0.95%. Sheila’s fund buys bank stocks, real estate stocks, energy stocks, and automotive industry stocks. Fund managers study the industries and companies and make buy and sell decisions based on their forecasts of the performance statistics of those companies.
Frequently Asked Questions (FAQs)
1. What percentage of actively managed funds outperform the market?
2. What happens when actively managed funds do not outperform the market?
3. Which Vanguard bond funds are actively managed?
4. Why do passively managed funds tend to have lower fees?
These are some common questions about active versus passive investing.
Source: https://www.thebalancemoney.com/actively-vs-passively-managed-funds-453773
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