Active vs Passive Management
Why Active Funds Are Not Worth It
“The mutual fund industry is, in a sense, a creation of witchcraft.” – John C. Bogle
When you decide to invest in a fund, you essentially have two options: active management or passive management.
If you turn to your bank, the vast majority of the time, they will propose an active fund. But what does this really mean?
What is an Active Fund?
An active fund is managed by a manager who decides what to buy, sell, and when. Their goal is to outperform a benchmark to justify the fees they charge.
For example, a fund investing in large-cap U.S. stocks might be compared to the S&P 500 index.
However, the key question is: do active funds actually beat the market in the long run?
Do Active Funds Really Work?
Over the years, numerous studies have shown that most active funds fail to beat the market over the long term.
A study by Morningstar revealed that only 45% of active funds outperformed passive funds in 2021. But it gets worse:
• Not all active funds survive over time.
• Of those that remain, only a small percentage continue to outperform the market.
And as the years go by, the percentage of active funds that beat passive ones decreases even further.
Another study by Morningstar found that, over a 10-year horizon, fewer than 23% of active funds succeeded in beating their benchmark.
This means that, on average, investing in an active fund does not pay off compared to choosing a passive solution.
Why Do Active Funds Fail?
There are several reasons why active funds fail to beat the market. Let’s break down some of them:
1) High Costs
Active funds charge much higher fees than passive funds.
• An ETF tracking the S&P 500 can have an annual cost of just 0.07%.
• An active equity fund in Italy has an average cost of 2.13% per year.
If you invest €10,000, an ETF costs you only €7 per year, while an active fund takes €213.
And that’s not all: there are also entry, exit, and performance fees, making it even harder to recover costs.
For an active fund, even if the market gains +10%, the fund must return at least +12.13% to match the net performance of an ETF.
2) The Problem of Compound Interest
Costs aren’t just an immediate expense; they have a huge impact in the long run.
Let’s say you invest €10,000 in an active fund that has the same gross return as the market (+10% annually) but charges a 2.13% fee.
After 15 years, the difference in returns between an active fund and an ETF replicating the same index becomes clear:
Fund Type: Capital after 15 years
ETF (0.07% fees): €41,772
Active Fund (2.13% fees): €33,129
You’ve lost over €8,000 just due to the fees.
If the fees were 3.5%, the difference would be even more dramatic: you’d have €16,000 less compared to an ETF.
3) Too Much Activity (And the Wrong Kind)
The idea behind active management is to choose undervalued stocks to generate superior returns.
In theory, this should work. In practice, data shows that fund managers:
• Fail to consistently pick the best stocks.
• Tend to move with the market rather than anticipate it.
A study referenced by CNBC suggests that market timing and stock picking don’t work because the market quickly incorporates all available information.
4) The Tendency to Hold Too Much Cash
Many active funds tend to hold more cash than necessary, thinking they can “time the market” and jump in at the right moment.
This leads to a problem: during downturns, funds tend to not invest, only re-entering once prices have already risen. The result? Poor returns for investors.
5) Pressure on Managers
Fund managers are evaluated on an annual or even quarterly basis.
This means they prefer to move with the crowd rather than make contrarian decisions that may pay off only in the long term.
This leads to ineffective investment strategies and returns that underperform compared to passive funds.
Why Passive Funds Are the Smarter Choice
Active management may sound appealing in theory, but the data shows that:
✔️ Most active funds don’t beat the market in the long run.
✔️ High fees significantly reduce net returns.
✔️ The excessive activity of managers often leads to poor decisions.
✔️ ETFs and passive funds cost less and provide better returns over time.
If your goal is to maximize returns over the long term, the most logical choice is to invest in low-cost ETFs that track market indices.