What is a Passively Managed Fund?

Howdy Wall St. Willy! Sometime ago we talked about Actively Managed Fund, but what is Passively Managed Fund?

Passively Managed Funds are funds in which the investment is made to mirror an index. That means that the securities in the passively managed fund are the same as in the index.

The investment is also not done based on any analysis. It just reflects the fund’s benchmark index. The idea is not to beat the market but to obtain return that consistently matches the return from the benchmark index.

Can I only invest in the entire market using an index fund?

No. The funds investments depend on the benchmark index.

If the benchmark index represents the entire market, say the Wilshire 5000, then the passively managed fund would invest in the entire market.

But, if the benchmark index represents a section of the market, say the S&P 500, which represents a bunch of large cap stocks, or the Russell 2000 which represents a bunch of small cap stocks, then the fund invests in those stocks.

The benchmark index could also represent a particular sector of the market, say the US IMI energy index which represents the energy, or oil and gas sector, in which case the fund invests in those stocks.

Well, what are the advantages of passively managed funds?

The biggest advantage is their very low cost or expense ratio because there is no need to hire research analysts. In fact, the expense ratio can be as low as 0.05%. That means that for every $100 you would invest in a passively managed fund; you’d only pay a 5-cent fee!

Also, the funds holdings are bought or sold only when the benchmark index’s constituents change. So, the trading is less frequent. This also contributes to lower costs and lower income tax.

Well, what are the disadvantages of passively managed funds?

Passively managed funds’ returns are limited to the returns from the benchmark index. There is no possibility of beating the market or getting returns that are better than then benchmark index’s returns.

Also, the funds investments are limited to the benchmark index and there is no flexibility to invest outside the index even if there is a great investment opportunity available.

Well, what asset classes do they invest in?

Passively managed funds invest in stocks, bonds and other securities.

Well, should I invest in passively managed funds?

For stock investments, passively managed funds are usually the best option and should form the core of every investment portfolio. However, for bond investments passively managed funds usually should be avoided.

Thank you very much for telling me about passively managed funds, Wall St. Willy.

You are welcome, Sooper Cooper. Remember, Finance is Your Friend!

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