Active vs. passive investing: What strategy is right for me?

Active and passive investing are two essential strategies that influence how investors build and manage their portfolios. The unique characteristics of each strategy involve tradeoffs that may be more or less favorable to investors depending on market conditions. What’s more, your specific goals and preferences can play an important role in navigating the tradeoffs in your portfolio.

Active management is a hands-on approach in which fund managers buy and sell securities based on an independent appraisal of their future prospects. This approach aims to attain returns that outperform or “beat” the market leveraging a risk and fee adjusted basis.

This strategy often requires a team of financial professionals, including analysts and portfolio managers, responsible for researching, monitoring, and trading the fund’s portfolio of securities.

What to consider:

• Flexibility: Portfolio managers can adapt their strategies to changing market conditions, especially by taking advantage of short-term opportunities and perceived distortions in market pricing.
• Market timing: Attempting to buy low and sell high means forecasting market movements. Especially in recent years, many managers have struggled to outperform the market – especially those who focus on large-cap growth US equity stocks.
• Higher fees: Due to both their staffing requirements and often higher trading expenses, active management typically carries additional costs for an investor over passively managed funds. Accordingly, these funds typically incur higher fees – sometimes much higher.
• Opportunities for active investing: Mutual funds are generally actively managed.

Passive investing is a long-term strategy that aims to match the performance of a certain market index.

The approach seeks to mirror the index by simply holding the same (or nearly the same) stocks in roughly the same proportions as in the index. Fund managers practice a buy-and-hold strategy with periodic rebalancing, with the anticipation of capital appreciation over time.

What to consider:

• Less diversification during periods of concentration: Passively managed funds are often less diversified if the underlying index, such as the S&P 500, is highly concentrated.
• Buy-and-hold: The key to passive investing is buying and holding rather than trying to time the market. Staying invested consistently has often outperformed attempts to predict market movements.
• Lower tracking error and fees: Passively managed funds typically involve lower fees, as they usually require less expense to run. This cost-efficient approach has helped passively managed funds to often outperform active management. Holding on to your investments in the long run minimizes trading frequency and also reduces costs that can impact profits.
• Opportunities for passive investing: Index funds that track indices like the S&P 500^® are generally passively managed and are typically exchange-traded funds (ETFs).

Both approaches have strengths and weaknesses that can complement one another in an overall portfolio. 

When it comes to deciding between the strategies, context can be a factor.

• Active investments have tended to outperform passive investments in volatile or declining markets, which allows more opportunities for stock-picking and risk-management to pay off.¹
• Passively managed funds may achieve better results in years when market performance is particularly strong, especially if that strength is driven by a small number of large stocks.
• Different regions, sectors, or asset classes may be better suited toward active – especially those which are less liquid, such as emerging markets.
• Passive management, on the other hand, has tended to be more effective in highly liquid markets with high trading volumes and large quantities of high-quality data, such as US large cap stocks.

When evaluating any fund, it’s important to assess not only returns, but also the organization, portfolio managers, transparency, and communications. Use resources such as a fund’s prospectus, website, commentary, and performance report to make the most well-informed decision possible. 

Perhaps the best part of active and passive investing is that investors don’t have to choose one or the other—they can use both.

Generally speaking, investors may benefit from a blended approach that mixes the characteristics of the two strategies, emphasizing their upsides while mitigating their downsides. Attention to the market environment and asset class in question can be important factors to consider. By combining approaches, investors may potentially benefit from a more balanced and diversified portfolio.

As always, any investing decisions should align with your individual goals, timeline, and risk tolerance.

Article Footnotes

¹ Passive vs. Active Investing: A Comprehensive Guide. October 14, 2024. https://www.morganstanley.com/articles/active-vs-passive-investing.

CRC# 4098401 04/2025