Passive vs. Active Investing: A Comprehensive Guide to Wealth Management

In recent years, a variety of investment vehicles have sprung up that allow you to invest "passively" in the market. Instead of trying to beat the market or reduce the risk inherent in it through asset selection, you ride the market for better or worse.

You can invest passively through index mutual funds, or with I-shares, which trade differently but perform similarly to index funds. The best known passive investments are S&P 500 index funds that invest in all 500 stocks, in the same proportion as the index. Some index funds track other market indexes, such as the international MSCI EAFE index " which includes stocks from 20 different countries " and the Lehman Brothers Aggregate Bond index.

Index funds are relatively easy for investment companies to manage because they require little research or trading. Therefore, their fees are generally much lower than those of actively managed funds. These investments are usually tax-efficient too, because there is little portfolio turnover. (As with all equity and fixed-income investments, however, index funds can be risky and their holdings can possibly decline in value.)

Active investing also features advantages and disadvantages. Using your own or your investment manager's research, you may be able to select securities that outperform major indexes and the general market. And if you own a large number of securities, your fees may be comparable to those of a passively managed portfolio.

By holding stocks long enough to avoid short-term capital gains taxes or investing in low-turnover mutual funds, you may also be able to achieve tax efficiency. Your investment expertise and ability to choose investments that, over time, outperform the market after expenses will determine whether the rewards of active management outweigh the risks.

So should you follow a passive or active strategy? It may depend on how you're investing, whether your assets are in taxable or tax-deferred accounts, and whether you manage them yourself or rely on advisors.