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Active vs. Passive Funds A passive (or index) fund is the easiest, most effective way for novice investors to enter the stock market. Index funds replicate the performance of major market indices by investing in all the stocks in the index in the same proportions as the index. The actual returns that investors realize from these funds are slightly less than the performance of the index due to fees. However, the fees charged by index funds are lower than those charged by actively managed funds. They are also better for reducing taxes, since their portfolio turnover is low. If you are a long-term investor seeking growth and don't have the time to put much time into money management, then an index fund is probably a good investment. Active funds are managed on a daily basis by a portfolio manager. He or she selects investments for the fund based on the fund's objectives. Due to the work involved in actively managing a fund, the management fees are quite a bit higher (usually percentage point or two vs. less than 1% for index funds). Since the portfolio manager is buying and selling stocks, there are capital gains tax liabilities that the fund must pass on to investors in the form of an annual distribution. Distributions are made to investors at the end of the year, and investors are required to pay capital gains taxes on the distributions. Active management gives investors the opportunity to beat the market indices. This is the goal of most active managers, although most managers fail to achieve this goal. It is imperative that investors take into consideration both the positives and the negatives of active funds, especially the added fees and tax consequences before making a purchase decision.

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