Index Funds vs Active Funds

An active fund employs a manager and research team to select stocks with the aim of beating a benchmark. An index fund simply replicates the benchmark, holding the same securities in the same weights.

Cost is the structural difference

No research team means a far lower expense ratio. That difference is guaranteed and compounds every year, whereas outperformance is uncertain and rarely persists across the same fund for long stretches.

Tracking error and tracking difference

Two numbers to check on any index fund: tracking difference (how far its return sits below the index, largely explained by cost) and tracking error (how consistently it follows the index). Lower is better on both.

Where active still earns its fee

Indexing is hardest to beat in the large-cap space, where information is widely available. Further down the market-cap scale, and in credit-sensitive debt, a good manager has more room to add value — though identifying that manager in advance remains the difficulty.