A passive (index) mutual fund closely follows an index, such as the S&P 500® Index, without much variation in underlying investments. In an active fund, portfolio managers carefully choose potential investments based on research and therefore charge higher fees for their services.
But what if the index isn’t doing well? The passive fund follows the index up, but it also follows it down. There’s not much opportunity for that passive fund to escape the index’s trajectory—great in an up market, potentially devastating in a down market.
After the financial crisis, most passive funds have followed their respective indices up, while active funds’ performance lagged those same indices. The story before that period, however, is telling: Active funds have historically outperformed passive during periods of market crisis and volatility and asset bubbles (the dot-com bubble in 1999-2000 and financials in 2008, for example), precisely because active managers didn’t have to mirror an index.
The “winning” type of fund, in this case, depends greatly on the overall market environment. Over time, active funds and passive funds each have cycles of outperformance. Passive’s run is the most recent. The answer, in our view, is to incorporate both approaches to further diversify your investments for varying market conditions.
Read more about the differences between active and passive investment strategies: Breaking Down Passive and Active Investing
The opinions expressed are those of Victor Zhang and are no guarantee of the future performance of any American Century Investments portfolio. For educational use only. This information is not intended to serve as investment advice.