Definitions

• Active money management refers to an investment strategy where portfolio managers use various techniques to generate a positive absolute return, or a return in excess of the return on a benchmark index. These techniques include stock or sector selection and market timing.
  
  Passive money management refers to an investment strategy where portfolios are constructed that replicate the constituents of a popular index like the S&P 500 or Russell 1000 index. This strategy guarantees that an investor will receive the same return that the market or index receives, less any transaction costs. This investment strategy is also called indexing.
  
  

Core Beliefs

• The intellectual basis for practitioners of active money management is a belief that the market is inefficient and individuals who are proficient at stock or sector selection can add value through increased returns above a benchmark index like the S&P 500.
  
  The intellectual basis for passive investment management is the belief that over the long term, an active investment strategy cannot achieve returns in excess of the market. This is due to market efficiency and the impact of higher turnover, which leads to higher capital gains taxes and trading costs.
  
  

History of Passive Management

• The earliest uses of passive investment management occurred in the early 1970s but were only available to certain corporate accounts or pension funds. These early efforts were considered failures due to an inability to replicate the index efficiently.
  
  In the late 1970s, the Vanguard Company created one of the first equity index mutual funds available to the general public. The fund was originally called the First Index Investment Trust, and now is called the Vanguard Index Trust 500 Index. The fund began operations on August 31, 1976, with $11.4 million under management, and has grown to $129.9 billion as of August 31, 2009.
  
  

Passive Management

• Passive money management has lower fees and costs than active money management. This is due to less turnover, or trading of the stocks in the index fund, and lower operating expenses and adviser fees charged by the fund.
  
  

Active Management

• The main advantage of active money management is, to state the obvious, higher returns, if the strategy is successful. Proponents of active management believe that this end result justifies the higher costs and expenses.