How active and passive funds work differently

Whether you’re building your portfolio, trying to diversify or considering new investments, understanding the difference between active and passive funds is extremely helpful. Both mutual funds and exchange-traded funds (ETFs) can be either active or passive.

The basics
Active and passive funds are fundamentally different in the way individual stocks and bonds within the funds are chosen. A fund’s portfolio manager selects the stocks and bonds for an active fund, while a passive fund tracks an index, like the S&P 500. The passive fund often uses a representative sampling method to “match” the characteristics of the index in the fund, and its intention is to reflect overall market performance.

Generally, active funds try to beat the market while passive funds try to reflect
the market. Active funds usually have higher fees but offer different investment

Side-by-side comparison
The two approaches differ in several ways. See a breakdown of some of the differences below:

How to choose
Active and passive funds both have distinct benefits, but which will serve you best depends on your goals, assets and other considerations as an investor. In many cases, a mix of both types of funds is a great fit. That’s where an advisor comes in: to help you understand which active and passive funds are available to you, and factor in your risk tolerance and time horizon to determine how either – or both – may be an appropriate choice for your portfolio.

Next steps
Before implementing a new investment, it’s good to consider how it will fit into your financial plan:
• Research the historical returns and expense ratios.

Nick Martin is a financial planner and the founder of Bluffton Financial Planning.
Bluffton Financial Planning is not a registered broker/dealer, and is independent
of Raymond James Financial Services. Investment advisory services offered
through Raymond James Financial Services Advisors, Inc.