First off, I love mutual and index funds. Nearly all of my stock investments are in one of these types of funds, the only exceptions being about $50 worth of a stock that I purchased as part of our coin finding competition and the company match that my employer gives me that is automatically invested in their stock by default. Other than this I have chosen to leave the management to the professionals and invest in funds that follow specific sectors or indices of the market. So most of my investment advice will trend along that line of thought.
But sometimes it can be hard to tell where a fund falls on the activity spectrum since active investing and passive investing are not black-and-white concepts – there is a lot of gray area. A fund can be managed in a more active or more passive way. The more research that is done, the more active the investing style is.
But let’s look at these strategies real quick:
Passive investing is often used interchangeably with index investing. In this context, passive investing is the practice of following an index, like the S&P 500. Roughly 37% of my current portfolio is in index funds that track to the S&P 500 (VFIAX and FXIAX). The goal of passive investing is to create a portfolio that contains the same funds as an index.
Because indices are created to show an overall picture of the market or a section of the market, passive investors who follow indices are trying to get returns that mirror a section of the market or the entire market (another 12% of my current portfolio is in an index fund that follows the entire US market (VTSAX)).
Another reason that I personally love passive investing in index funds is because their expense ratios are considerably lower since the funds management is spending less on managing the fund. Meaning that you are paying less to own the fund. (for my index funds I pay .05% of the fund annually as the expense ratio but my other funds are between 1.12% (yuck) and .22%).
Conversely, Active investing aims to beat the market, whereas passive investing generally aims to keep pace with the market. Active investing requires more research because active investors must choose their investments rather than using the companies from an index. The most actively managed mutual funds are those that do not remotely attempt to track any index. These funds have goals and philosophies that guide fund managers in deciding which assets to use within the funds.
While I love my index funds and rely on them for consistency and security, I use more actively managed mutual funds to offset some of the conservatism and look for higher returns without leaving the security of diversification completely (another 41% of my current portfolio is in actively managed funds). The other two funds that I hold in my Vanguard account are VGHCX and VHCOX which are both actively managed. VGHCX attempts to track to the health care sector of the market and VHCOX is an aggressive fund that attempts to invest in companies that are expected to have substantial growth over time.
Anyways, this post was intended to be a short explanation of the two and I wasn’t really planning to go into my personal preferences and portfolio but got a bit carried away and can’t make myself exclude it now that it’s out. Hope this was helpful as you continue to seek for the investment strategy that works best for your personality. Let me know if you have any additional questions cause I could keep going about the rationale behind my investment decisions but need to cut myself off at some point.