There are two broad categories of asset management when it comes to investing in funds. There are passively managed funds, and then there are actively managed funds. Both have it’s unique characteristics along with its set of advantages and disadvantages.
Actively Managed Funds
This type of fund is what most people think of when we talk about mutual funds. You picture a money manager or a team of analysts scouring the market for good stock picks. Based on a certain investment strategy, they will evaluate companies looking for good deals. Then those same people watch the fund like a hawk to see which stocks to keep and which ones to get rid of.
One of the advantages to actively managed mutual funds is that they are run by human beings. You have real people thinking through the pros and cons of each company. Sometimes they even visit those companies to get a human perspective on the business and management.
That same advantage also brings disadvantages. The fact that real live human beings managed these funds make it very expensive. It is reflected in usually high management fees.
In addition, you also get human error. Studies have shown that, with some exception, most mutual fund managers don’t beat the market over time.
Passively Managed Funds
These funds are ones that are usually managed by a computer. They usually follow some kind of index, like the S&P 500 or Russell 3000 in the case of small cap funds. It may also use some kind of proprietary, automated trading software. In any case, these tend to have lower costs associated with them because it takes less human capital.
In many cases, these funds also perform better. Index funds that follow indices tend to grow over time because the stock market in general has proven itself to grow over time. It may not be extravagant earnings, but they beat most actively managed mutual funds.
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