"We tell clients that we're indifferent to whether it's passive or active, from a philosophical standpoint," said certified financial planner Shon Anderson, president and chief wealth strategist at Anderson Financial Strategies. "Whatever has the best performance in that asset class is what we'll put in a portfolio."
Whether all the new money flowing into passive strategies follows the same philosophy is hard to know. But data from research firm Morningstar show that whatever the reasons may be — lower costs, tax efficiency, better performance — passive investments continue to gain new money as traditional actively managed mutual funds watch money leave their coffers.
Year to date through August, active mutual funds saw $153 billion in outflows. On the other hand, index funds — which are passively managed — pulled in nearly $145 billion in new money during the same time. Additionally, about $138 billion flowed into passive exchange-traded funds.
Nevertheless, actively managed funds still hold significantly more assets than passive investments: $9.7 trillion vs. $2.8 trillion in index funds, and $2.4 trillion in standard ETFs. (Actively managed ETFs — which in simple terms are a combination of indexing and active management — held about $27 billion in assets at the end of August.)
But before deciding where your money should be, it's important to understand the pros and cons of both active and passive approaches.
Passively managed funds include index funds and, in general, ETFs. Index funds, as their name implies, mimic a particular market index, both with holdings and exposure to each holding. Most ETFs do the same thing, but trade throughout the day like stocks.
This means that the fund's or ETF's performance will also track the performance of the index. If the index goes up, the funds and ETFs tracking it also rise. But it also means if the index goes down, so do the funds.