Learning Center

Back

Passive, Active, or Both?

As demonstrated by the extreme market volatility in the first half of 2020, it’s very difficult to anticipate the direction of the financial markets. That’s one reason why index mutual funds and exchange-traded funds (ETFs) have drawn increasing interest from investors.

These passively managed investment funds are designed to match the performance of a particular market index by owning the same securities included in the index. The underlying concept is that rather than trying to “beat the market,” an index fund owns shares of a particular market segment. Today there are hundreds of indexes and index funds tracking various types of assets.

Index funds increased their share of the fund market from $8.5 trillion in total net assets in 2009 to $22 trillion in 2019.

Trying to Pick Winners

Despite the growing interest in index funds, actively managed funds still hold more assets (see chart). However, even professional fund managers struggle to beat the market.

According to Morningstar, about 47% of active funds outperformed the average of passive funds in their category in 2019. This was a relatively strong performance and an improvement over 2018, when only 35% outperformed. The success rate over the 10-year period from 2010 to 2018 was just 23%.1

Although these statistics suggest that indexing may be the stronger approach over the long term, active and passive funds tend to perform differently over different market cycles, and they might serve a variety of purposes in your portfolio. Some analysts believe that active management may be more effective than indexing in navigating what is expected to be uneven performance of companies and industries during the economic recovery.2

Here are some pros and cons of each type of fund.

A Simple Approach

The primary appeal of index funds is cost-efficient simplicity. Because these funds have less managerial involvement, fees are often lower than they are for actively managed funds. Index funds may also buy and sell assets less frequently, and lower turnover may help reduce capital gains distributions. Tax efficiency could be an important consideration when funds are owned in taxable accounts.

The simplicity of index funds can be both a positive and a negative. Many of the well-known, third-party indexes that are commonly tracked by index funds are broad based and capitalization weighted. Thus, index investing traditionally involves buying all the securities in a market or market sector and weighting them based on their value in the marketplace. While this is a good way to capture a selected part of the market, it places heavy emphasis on a relatively small number of large companies in the index. At the same time, an index fund must hold all the securities in the index regardless of the potential performance of an individual company.

Hands-On Strategies

Active fund managers strive to outperform benchmarks by hand-picking securities based on research and a defined investment strategy. Thus, actively managed funds offer the chance to outperform the overall market, although most of them historically have not.

An actively managed fund may be more diversified than an index fund holding stocks in the same asset category, because the manager can choose to weight the securities to meet the fund’s objective rather than following the market capitalization structure of an index. Diversification is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.

Active managers also have more flexibility and may use a variety of trading strategies to help manage risks. For these reasons, some actively managed funds might offer defensive benefits when markets are falling, and they may be able to take advantage of specific market movements that might not be captured in an index fund.

There is ongoing discussion in the financial media around whether investors are better off using active or passive investing strategies, but there is no need to pick a side in the debate. Depending on your goals and risk profile, there may be plenty of room in a well-diversified portfolio for both types of funds.

The return and principal value of stocks, mutual funds, and ETFs fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. The performance of an unmanaged index is not indicative of the performance of any specific security. Individuals cannot invest directly in an index. Past performance does not guarantee future results. Actual results will vary.

Mutual funds and ETFs are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

 

Information provided has been prepared from Broadridge Advisor Solutions sources and data we believe to be accurate, but we make no representation as to its accuracy or completeness. Data and information is provided for informational purposes only, and is not intended for solicitation or trading purposes. Broadridge Advisor Solutions is not an affiliate of Equitable Advisors, LLC. Please consult your tax and legal advisors regarding your particular circumstances. Neither Equitable Advisors nor any of the data provided by Equitable Advisors or its content providers, such as Broadridge Advisor Solutions, shall be liable for any errors or delays in the content, or for the actions taken in reliance therein. By accessing the Equitable Advisors website, a user agrees to abide by the terms and conditions of the site including not redistributing the information found therein.

Securities offered through Equitable Advisors, LLC (NY, NY 212-314-4600), member FINRA, SIPC. Annuity and insurance products offered through Equitable Network, LLC and its subsidiaries.

California Insurance License #: OL72692

Securities offered through Equitable Advisors, LLC (NY,NY 212-314-4600), member FINRA/SIPC (Equitable Financial Advisors in MI & TN). Investment advisory products and services offered through Equitable Advisors, LLC, an SEC registered investment advisor.

Annuity and insurance products offered through Equitable Network, LLC, which conducts business in CA as Equitable Network Insurance Agency of California, LLC, in UT as Equitable Network Insurance Agency of Utah, LLC, and in PR as Equitable Network of Puerto Rico, Inc. Equitable Advisors and its affiliates do not provide tax or legal advice. Please consult your tax and legal advisors regarding your particular circumstances. Individuals may transact business, which includes offering products and services and/or responding to inquiries, only in state(s) in which they are properly registered and/or licensed. The information in this web site is not investment or securities advice and does not constitute an offer.

Equitable Advisors, LLC is an Equal Opportunity Employer M/F/D/V

For more information about Equitable Advisors, LLC you may visit equitable.com/crs to review the firm’s Relationship Summary for Retail Investors and General Conflicts of Interest Disclosure. Equitable Advisors and Equitable Network are brand names for Equitable Advisors, LLC and Equitable Network, LLC, respectively.

Link to equitable.com

Privacy Policy

Check the background of this financial professional on FINRA's BrokerCheck
Check the background of this financial professional on FINRA's BrokerCheck