Ideally, you want to create a balanced portfolio while keeping costs down. Most investors lean on mutual funds, index funds and exchange-traded funds to do that. Rather than betting on any one company stock, these funds pool multiple stocks together, balancing out the inevitable losers and winners.
And these funds are built on passive management strategies. Passive investing seeks only to match wider market gains, as opposed to active investing that tries to outperform the market by frequently buying and selling stocks. And while having an expert pick and choose stocks for you may sound appealing, in the five years leading up to Dec. 31, 2019, 80% of large-cap funds underperformed the S&P 500. In other words, if you’d invested in a low-cost index fund that closely tracks the S&P 500, there’s a good chance you would have seen better returns than in the average mutual fund.
Passive investing also brings fewer of the fees that can erode long-term investment growth. In 2019, the average passively managed fund had an asset-weighted expense ratio of 0.13%, compared with 0.66% with actively managed funds. This cost difference has sparked a growing array of robo-advisors that automate portfolio management, which allows these companies to charge much lower fees than actively managed accounts.