Two parents are laughing with their child.
Understanding investment types

Index funds vs. actively managed funds

The choice comes down to how much risk you're willing to take for the possibility of higher performance.
3 minute read

What’s the difference between index and active funds?

Index mutual funds & ETFs

Index funds are designed to keep pace with market returns because they try to mirror certain market segments. 
 

Actively managed funds

Active funds try to beat market returns with investments hand-picked by professional money managers. 

Compare indexing & active management

Each strategy has a unique method for selecting its underlying investments. And each can complement the other when combined in a well-diversified, balanced portfolio.

Portfolio

 

The total of all your investment holdings.
  Index mutual fund or ETF Actively managed fund
Goal Tries to match the performance of a specific market benchmark (or "index") as closely as possible. Tries to outperform its benchmark.
Strategy Buys all (or a representative sample) of the stocks or bonds in the index it's tracking. Uses the portfolio manager's deep research and expertise to hand-select stocks or bonds for the fund.
Risk Aligns directly to the risks involved with the specific stock or bond market the fund tracks.

Adds the risk that the portfolio manager may underperform its benchmark.

Active management performance history
Tax efficiency Usually distributes fewer taxable capital gains because the portfolio manager trades less frequently. Could have more taxable capital gains because the portfolio manager may trade more often, making it more tax-efficient to hold actively managed funds in IRAs.

Market benchmark

An unmanaged group of bonds or stocks whose overall performance is used as a standard to measure investment performance.

Stock

Usually refers to common stock, which is an investment that represents part ownership in a corporation. Each share of stock is a proportional stake in the corporation's assets and profits.

Bond

A loan made to a corporation or government in exchange for regular interest payments. The bond issuer agrees to pay back the loan by a specific date. Bonds can be traded on the secondary market.

Active management performance history

 

Over the past 15 years, only about 35% of active stock fund managers and 41% of active bond fund managers have outperformed their designated benchmarks.*

Active stock fund managers

35% outperformed benchmarks.

65% underperformed benchmarks.
 

Active bond fund managers

41% outperformed benchmarks.

59% underperformed benchmarks.

 

*Sources: Vanguard calculations, using data from Lipper, a Thomson Reuters Company. Based on funds' excess returns relative to their prospectus benchmark for the 15-year period ended December 31, 2023. Only funds with a minimum 15-year history were included in the comparison. Results for other periods will vary.

Capital gains

An increase in the value of an investment over the initial purchase price. A capital gain is "unrealized" until the investment is sold, when it becomes a "realized" gain. Realized gains are taxable, but the tax burden is deferred if you hold the investment in an IRA or a 401(k).

Index mutual fund or ETF

Goal

Tries to match the performance of a specific market benchmark (or "index") as closely as possible.

Strategy

Buys all (or a representative sample) of the stocks or bonds in the index it's tracking.

Risk

Aligns directly to the risks involved with the specific stock or bond market the fund tracks.

Tax efficiency

Usually distributes fewer taxable capital gains because the portfolio manager trades less frequently.

Actively managed fund

Goal

Tries to outperform its benchmark.

Strategy

Uses the portfolio manager's deep research and expertise to hand-select stocks or bonds for the fund.

Risk

Adds the risk that the portfolio manager may underperform its benchmark.

Active management performance history

Tax efficiency

Could have more taxable capital gains because the portfolio manager may trade more often, making it more tax-efficient to hold actively managed funds in IRAs.

Browse Vanguard’s index mutual funds

Browse Vanguard’s actively managed funds

Still not sure which is right for you?

See how our index funds can work for you

See how our active funds can help you meet your goals

You must buy and sell Vanguard ETF Shares through Vanguard Brokerage Services (we offer them commission-free) or through another broker (which may charge commissions). See the Vanguard Brokerage Services commission and fee schedules for full details. Vanguard ETF Shares are not redeemable directly with the issuing fund other than in very large aggregations worth millions of dollars. ETFs are subject to market volatility. When buying or selling an ETF, you will pay or receive the current market price, which may be more or less than net asset value.

All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. 

Fluctuations in the financial markets and other factors may cause declines in the value of your account. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.