Active management entails individual security selection, while passive means investing based upon some market index such as the Dow Jones Industrial Average, S&P 500 or Russell 2000.  Passive means you're not selecting individual securities but investing in a broad market index typically comprised of hundreds of securities.  Your results will very likely track that index over time quite closely.  No chance to underperform, but also no chance to outperform, either.

 

Traditional "open-ended" passive mutual funds that track stock market indexes were devised years ago to cater to this approach.  But they weren't enough for the marketing departments of some investment companies.

 

These creative folks took the concept one step further, and not for the better in our opinion.  You see, open-end mutual funds don't trade during the day.  The value at which you buy or sell your fund shares is determined only at the end of the trading day.  The product pushers came up with Exchange Traded Funds-ETFs-which as the name implies trade on a stock exchange.  You can trade these instruments all day long.

 

What's wrong with that, you ask?  Isn't more liquidity and ability to trade anytime a good thing?  Theoretically yes.  Practically speaking, no.  Why?  Because like bees attracted to honey, many people crave the excitement of trading.  Unfortunately, studies have confirmed, the more you trade, the worse you do.

 

In addition, the product people who invent this stuff have come up with narrower slices of the investment world to offer to hopeful investors.  Now you can buy an ETF to suit a very specific investment need.  Even needs you didn't know you had.  Leveraged ETFs.  Inverse ETFs.  Leveraged Inverse ETFs.  Exchange Traded Notes.  Single Country ETFs.  Currency Hedged Foreign ETFs.  Sector ETFs.  Single Commodity ETFs. Volatility ETFs.  I think there's even one to invest in Mongolia.  You say don't know what most of these do?  Relax, join the club, neither do many of the people buying these "products".

 

For most investors, the best thing you can do is try to take steps to improve your chances for success.  Don't invest in things you can't understand, or pronounce.  Don't invest in products or vehicles that encourage frequent trading.  Instead, find an active manager you trust, with a clear philosophy and process geared toward long term results.  Or pick a passive broad market index fund that provides market returns with minimum effort. 

 

In either case, we urge you to resist the temptation to monitor your investments too frequently, for that tends to lead to more trading activity.  The paradox is the more trading you do, the less success you might achieve.