3-2 Index and Active
A page separating index funds from active funds by whether they aim for the market average or leave it to a manager to beat it
3-1 established that a mutual fund holds several assets together. Next: how are those holdings run? Index and active are the categories that divide how a fund is managed. Index aims for a return close to the market average. Active leaves security selection and weighting to a manager, aiming for a return above the market average.
- Index and active are categories for how a fund is managed.
- Index aims for a return close to the market average.
- Active leaves it to a manager, aiming for a return above the market average.
1. Index means going out and holding the whole market as it is
An index fund aims to track an index such as TOPIX, the S&P 500, or a global equity index. The idea is simple: I want to hold the market average as it is. For someone contributing over the long term, low cost and being able to see what is inside are significant advantages.
| Index | In one line |
|---|---|
| S&P 500 | A broad look at 500 representative US large-cap companies |
| Nikkei 225 | A Japanese share price index based on 225 representative names |
| TOPIX | A Japanese equity index covering TSE Prime listings broadly |
| MSCI World | A broad aggregation of developed-market equities |
| MSCI ACWI | A global equity index adding emerging markets to developed |
| MSCI Emerging Markets | An index bringing together emerging-market equities |
2. Active means leaving it to a manager to aim above the average
An active fund has a manager changing holdings and weights based on company research and a read on the economy, aiming to beat the market average. When it works, you can expect a result above the index; equally, it can fall below the index. Generally, cost is higher than an index fund by the amount of research, analysis, and trading judgement the manager adds.
Even among active funds, one holding global equities broadly, one concentrating in a few high-quality names, and one combining non-equities differ in both the result you should expect and how their risk shows up. When looking at a track record, you also need to ask which index should this be compared against and in which conditions was it strong.
3. Which is better depends on your purpose
It is not that index funds are always right and active funds always at a disadvantage. What matters is what you want from a fund.
If you want broad exposure to the whole market, to keep going for a long time at the lowest cost you can, or the reassurance of being able to see what is inside, the index approach tends to fit. Because it aims to track an index, the yardstick for its movement is easy to see, and it pairs well with long-term contributions.
If instead you want a result above the market average, you see value in a manager's research and judgement, or you want to invest along a particular theme or policy, there are reasons to choose an active fund. When the management works, it can beat the index — and by the same token, the outcome depends on the manager's judgement.
For a beginner, simply grasping the difference between a product aiming for the market average and a product aiming to beat it is enough. From there, when you are unsure, asking whether you weight clarity and staying the course or the hope of beating the average makes the choice easier to sort out.