Passively vs. Actively managed funds. What does it mean?

*This post may contain affiliate links. This post is not investment advice, you will have to do your own research and determine if stock holdings or funds are right for you*

You’re beginning to invest. You see the stock market and everyone talking about investing and you want to learn how to be successful doing that. There are so many terms like stocks, shares, index funds. It can be overwhelming.

You see successful investors like Warren Buffet and want to apply his skills.

If you are looking to start investing, then Charles Schwab is a good place to start. They have a wide variety of funds to choose from and for the most part, they do not charge a lot of fees.

Now, many people in the FI/RE community are proponents of investing in index funds. Which is a set it and forget it method. This way is less research as you do not have to research individual stocks. Index funds are made up of a certain percentage of several hundred to several thousand stocks.

For instance: SWPPX has holdings in several technology stocks so you do not have to buy a whole share of it. Instead, an index fund allows you to (essentially) buy fractional shares.

Actively managed funds are managed by a team or an individual and they make decisions on how to invest the fund’s money.

On the other hand, passively managed funds do not have a team and they follow the market index, simply put.

Pros and Cons

Actively managed funds make it possible to beat the market, however, the majority of them underperform. So, it is best to read about their history and look at their statistics. They tend to be more expensive, as whenever they sell a holding the fund is taxed, this diminishes their performance. They also tend to charge a flat fee, sometimes over 1%. This means if your fund earns 7% in one year, you only 6%.

Passively managed funds are safer, as they will mirror the market. Neither under- or overperforming. They also tend to have cheaper management fees. This means that less of your earnings go to fees.

The diagram below explains it well.

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