Passive Investing: Focusing on Costs
Advocates of unmanaged, passive investing--sometimes referred to as indexing--have long argued that the best way to capture overall market returns is to use low-cost market-tracking index investments. This approach is based on the concept of the efficient market, which states that because all investors have access to all the necessary information about a company and its securities, it's difficult if not impossible to gain an advantage over any other investor. As new information becomes available, market prices adjust in response to reflect a security's true value. That market efficiency, proponents say, means that reducing investment costs is the key to improving net returns.
Indexing does create certain cost efficiencies. Because the investment simply reflects an index, no research is required for securities selection. Also, because trading is relatively infrequent--passively managed portfolios typically buy or sell securities only when the index itself changes--trading costs often are lower. Also, infrequent trading typically generates fewer capital gains distributions, which means relative tax efficiency.
Note: Before investing in either an active or passive fund, carefully consider the investment objectives, risks, charges, and expenses, which can be found in the prospectus available from the fund. Read it carefully before investing. And remember that indexing--investing in a security based on a certain index--is not the same thing as investing directly in an index, which cannot be done.