How Can I Determine if a Fund Follows a “Passive” Approach?

Heidi wrote me in response to my active vs. passive investment fund performance article and had some insightful questions for me.

How can I tell if my Vanguard funds are considered “passive?”

An excellent question! And one I hadn’t discussed here at 20somethingfinance yet – an opportunity for teaching back-to-the-basics lessons! Thanks so much, Heidi, for asking this great question.

To answer that question, let’s step back a little and discuss what active and passive fund management are first of all.

What Is Active Fund Management? Actively managed funds (MFs) involve having one or multiple investment managers make subjective buy and sell decisions on individual equities (stocks and bonds) within their fund’s assets, in the hopes of selecting investments with maximum return potential for investment purposes. Essentially, this means owning what they want when they want, with hopes of selecting investments with maximum ROI potential; similarly they sell investments when desired as well.

As compensation for their services, active fund managers often charge significantly higher management fees (expense ratios) than passive funds due to having to remunerate the fund management team.