Passive management is an investment strategy that seeks to replicate the performance of a specific index or benchmark, rather than outperforming the market through active stock selection and trading. This approach involves constructing a portfolio that mirrors the components of an index, such as the S&P 500 or the FTSE 100, and holding those investments over the long term with minimal buying and selling. The main goal of passive management is to achieve returns that closely match the index's performance, acknowledging that consistently outperforming the market through active management is difficult and often results in higher costs due to frequent trading and research expenses.
Because passive funds do not require the same level of research and active trading as their actively managed counterparts, they typically incur lower management fees and transaction costs. This can result in higher net returns for investors over time, especially when compounded. Passive management also offers transparency and predictability, as investors know which assets are held in the portfolio and can expect performance closely aligned with the tracked index. Furthermore, the strategy is based on the belief in market efficiency, which posits that all available information is already reflected in asset prices, making it challenging to consistently achieve higher returns through active management.
However, passive management also means that a fund will not outperform its benchmark; it simply aims to match the benchmark's performance, minus any fees. During market downturns, passive funds will generally experience declines in line with the index they track, without the possibility of strategic adjustments to mitigate losses. Despite these considerations, passive management has gained significant popularity among investors seeking diversified exposure to the markets, lower costs and the long-term benefits of riding out market volatility.
This Trustnet Learn article was written with assistance from artificial intelligence (AI). For more information, please visit our AI Statement.