Passive vs Active Management

Passive and active are two styles of portfolio management.
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Passive portfolio management requires minimal attention from the investor, and once initiated, is left alone with little or no intervention.

Passive management is often referred to as index investing and seeks to match the broader market indices’ returns. This is primarily accomplished by purchasing the stocks that comprise an index fund or purchasing ETFs designed to replicate the performance of the major indices with the intention of holding positions long-term.

A passive portfolio will perform similarly to the overall market and has historically performed well over long time frames.

One benefit of passive portfolio management is lower trading costs and lower management fees. 

Active portfolio management involves buying and selling assets with the aim of outperforming the broad market indices via active market participation. Active portfolio management requires more attention and may have higher associated trading costs.

Active management uses specific strategies designed to use fundamental and/or technical analysis to time purchases and sales in an attempt to gain an edge over the long-term buy and hold strategy of passive portfolio management.

Actively managed ETFs and mutual funds typically charge higher management fees than passively managed funds.

Dollar-Cost Averaging

Dollar-cost averaging is a long-term, passive investment strategy where investors purchase an equal dollar amount of a stock, mutual fund, or ETF at regular intervals. 

Dollar-cost averaging does not attempt to time the market and seeks to avoid the common misstep of “buying high and selling low.” Instead, as the price of the stock, mutual fund, or ETF increases, fewer shares are purchased. The opposite is true if price decreases: more shares are purchased at a lower cost. Buying shares over time lessens the impact of short-term volatility. 

The average cost of the shares is the total amount invested divided by the number of shares purchased. To realize a profit, the shares must be sold at a higher price than the average cost of the shares.

Dollar-cost averaging example buying $100 worth of stock monthly

By default, many investors utilize dollar-cost averaging for their retirement investing. As savers make regular retirement account contributions with each paycheck, the fixed amount invested with each paycheck buys differing amounts of shares. Similarly, employees may purchase shares of their company’s stock through employee stock purchase plans in fixed amounts over defined intervals. 

Dollar-costs averaging takes advantage of the assumed rise in asset prices over time. Dollar-cost averaging does not eliminate or hedge downside risk, but fixed dollar-amount purchases buy more shares of stock during market downturns and help a portfolio recover quicker if stock prices reverse and move higher.

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FAQs

Do active funds outperform passive funds?

The historical returns of individual funds varies. Active portfolio management involves buying and selling assets with the aim of outperforming the broad market indices via active market participation.

Active portfolio management requires more attention and may have higher associated trading costs. Active management uses specific strategies designed to use fundamental and/or technical analysis to time purchases and sales in an attempt to gain an edge over the long-term buy and hold strategy of passive portfolio management.

Is Warren Buffett an active or passive investor?

Warren Buffett is perhaps the most widely known value investor in the world and continues to actively manage the accounts of Berkshire Hathaway. Buffet typically has a long-term buy and hold approach which does not demand daily trading activity.

However, because he is invested in individual companies as well as index funds, he would be considered an active investor. 

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

Passive funds often have the word “index” in the fund name or description. Passive portfolio management requires minimal attention from the investor, and once initiated, is left alone with little or no intervention.

Passive management is often referred to as index investing and seeks to match the broader market indices’ returns. This is primarily accomplished by purchasing the stocks that comprise an index fund or purchasing ETFs designed to replicate the performance of the major indices with the intention of holding positions long-term. A passive portfolio will perform similarly to the overall market.

Active portfolio management involves buying and selling assets with the aim of outperforming the broad market indices via active market participation. Active portfolio management requires more attention than passive portfolio management and typically includes multiple individual securities, as opposed to index funds and similar ETFs.

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