What Is Passive Investing?
Passive investing is a long-term investment strategy that aims to match the performance of a market index rather than beat it. The idea behind it is straightforward: consistently outperforming the market is difficult, so instead of trying, investors aim to replicate it.
This article covers how passive investing works, how it compares with active investing, the pros and cons of each and how to get started.
The information in this article is provided for educational purposes only and does not constitute financial advice. Consult a financial advisor before making investment decisions.
Table of Contents
What Is Passive Investing?
Passive investing is an investment approach by which investors attempt to track the performance of a market index rather than outperform it. Key characteristics of a passive approach include:
- Tracking an Index: Rather than attempting to pick individual winners, passive investors usually hold a fund designed to replicate a market index, such as the S&P 500 or FTSE 100.
- Buying and Holding: Positions tend to be held for the long term.
- Low Fees: Less trading and no active stock-picking generally result in fewer fees.
- Matching the Market: The aim is to mirror the market's performance.
Passive investors work under the assumption that, over sufficiently long periods, markets tend to rise. Consequently, rather than attempting to beat the market, the strategy is to hold a representative slice of the market and let that growth play out over time. This is often referred to as a "buy and hold" approach.
Passive investing stands in direct contrast to active investing, which we'll cover in detail later in this article.
How Does Passive Investing Work?
A passive fund, whether structured as a mutual fund or an ETF, builds its portfolio to mirror an underlying index.
For example, an ETF which tracks the S&P 500 will hold exposure to the index’s 500 constituents in the same proportion as the underlying index. If Apple has a 5% weighting in the S&P 500, the ETF would aim to weigh Apple at roughly the same proportion.
Because the fund isn't trying to outperform the market, there's no need for a team of analysts hunting around for opportunities. Holdings typically only change when the underlying index changes during periodic reshuffles.
The result is a portfolio that rises and falls with the market it tracks at a comparatively lower cost, thanks to reduced management fees.
However, passive funds do not tend to track their benchmark exactly. Fees, trading costs, cash holdings and replication methods can create an ongoing gap between a fund's return and the return of its underlying index. This gap is known as tracking difference.
Why Has Passive Investing Become So Popular?
A few factors explain the shift towards passive investing in recent years:
- Lower Costs: Without active management, passive funds typically charge considerably lower fees, offering investors broad diversification at a lower cost.
- Strong Long-Term Record: Evidence on long-term fund performance suggests that passive funds outperform active funds over the long-term
- An Increasing Product Range: The number of available index funds have expanded considerably in recent years, covering a range of different economies and sectors.
The result has been a significant rise in capital flowing towards passively managed funds in recent years.
Passive funds have grown from around a quarter of global fund market share in 2016 to 44% in 2025. Furthermore, total assets in US passive mutual funds and ETFs overtook those in active ones for the first time in 2024.
Active vs Passive Investing
Active investing is the opposite approach to passive investing. Instead of replicating a market index, an active fund manager, or individual investor, selects specific securities they believe will outperform the market.
The difference between active and passive funds comes down to a simple question: does the manager try to beat the market, or to match it? Whilst passive funds aim to track a benchmark, active funds aim to outperform one.
Active vs Passive Performance
Long-running research consistently shows that the majority of active fund managers fail to outperform their benchmark over the long-term.
The S&P Dow Jones Indices SPIVA scorecard measures actively managed funds against their benchmark. In 2025, 79% of all active large-cap US equity funds underperformed the S&P 500, up from 65% in 2024, marking the fourth-worst year in the 25-year history of SPIVA scorecards.
It’s over the long-term where the picture looks particularly weak for active managers. Across 15 years, only 10% of all active large-cap US equity funds have outperformed the S&P 500.
This highlights one of the main drawbacks of active investing: whilst performance may vary from year to year, over the long-term, it can be very challenging to outperform the market.
The figures quoted above are specifically for US large cap equity funds. However, the pattern appears to repeat itself throughout the SPIVA data for different geographies and fund categories; over the long-term, the majority of actively managed funds underperform their benchmark.
Nevertheless, it’s important to remember that past performance is not a reliable indicator of future results.
Pros and Cons of Passive Investing
Like all approaches to investment, passive investing has trade-offs as well as benefits.
Advantages of Passive Investing
- Lower Fees: No research team and less frequent trading generally keep ongoing charges down. Even small differences in fees can make a significant difference over the long-term.
- Broader Diversification: A full index tracker holds all, or almost all, of its benchmark's constituents.
- Transparency: Holdings mirror an index, so it's clear exactly what is owned.
- Tax Efficiency: Passive investors tend to trade less frequently than active investors, which can result in fewer taxable events, depending on local rules.
- Difficult to Beat Market Consistently: It is very challenging to outperform the market over the long-term. Indeed, most professional active managers fail to do so.
Disadvantages of Passive Investing
- No Potential for Outperformance: A passive fund is designed to match its benchmark, not to beat it, even when opportunities to do so exist.
- Full Exposure to Downturns: When the index falls, the fund falls with it. Fund managers cannot reduce exposure to certain assets or position themselves defensively.
- Concentration Risk: Market cap-weighted indices, such as the S&P 500, can be dominated by their largest constituents. For example, the top 10 companies in the S&P 500 accounted for almost 40% of its total weight in early 2026, up from roughly 19% a decade earlier.
Types of Passive Investments
Passive investing typically involves investing in index funds, also known as tracker funds, which are designed to replicate an underlying index. These index funds can be structured as either:
- Mutual Funds: Funds which can only be bought and sold at the end of the trading day at the net asset value (NAV).
- Exchange-Traded Funds (ETFs): Funds that trade throughout the day on a stock exchange, in the same manner as a company's shares.
A passive portfolio is often built by combining a number of index funds to cover different markets or asset classes.
Index Mutual Funds vs Index ETFs: What's the Difference?
Index mutual funds and index ETFs both aim to replicate an underlying index as closely as possible. The main differences come down to how they're traded and structured.
Whilst ETFs are often associated with lower costs, in reality, it can vary depending on the index fund in question.
How to Start Passive Investing
Regardless of which broker you choose, passive investing generally follows a similar sequence:
- Define your goals and time horizon: This shapes which investments might be suitable for you.
- Choose an index to track: There are a wide variety to choose from, including global equity indices, such as the FTSE All-World, and more specific regional or sector indices.
- Choose a specific mutual fund or ETF, and a broker to buy it through: The fund structure and the broker it's bought through can affect costs and how it's traded.
- Compare the fees: Ongoing charges can vary between funds tracking the same index. Whilst differences may be small, these can compound significantly over long holding periods.
- Hold and review: Passive investors typically hold their positions over the long-term, but it can be sensible to review your holdings periodically.
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Frequently Asked Questions
Is Passive Investing Suitable for Beginners?
Passive investing often features in conversations about strategies that are suitable for beginners, particularly because it doesn't involve individual stock picking. Buying an index fund can offer instant diversification across hundreds of assets at a typically lower ongoing cost than many alternatives. However, like all investments, passive investments carry risk and investors will still need to choose an index to invest in, which will require research.
Can You Lose Money with Passive Investing?
Yes. Passive investments can fall in value when the index they track declines. Furthermore, a passive fund has no scope to reduce exposure to market declines, as it's designed to track its benchmark regardless of what's happening in the market.
Is Passive Investing Better than Active Investing?
There's no one answer. It depends on the individual investor in question. Long-term performance data shows that most actively managed funds underperform their benchmark over time, which partly explains why passive investing has grown so much in popularity in recent years. However, results can vary by market and time period.
What's the Difference Between Passive Investing and Passive Income?
Passive investing describes a hands-off, buy-and-hold investment strategy that aims to match a market index. Passive income describes any income generated with little ongoing effort, such as dividends, interest or rental income. It can be generated from either passive or actively managed investments.
Are ETFs Active or Passive?
ETFs can be either active or passive. Whilst they are typically associated with passive management, there are a growing number of actively managed ETFs available to investors.
Do Passive Index Funds Pay Dividends?
Many do but it depends on the underlying index and the share class of the fund. If the underlying index includes dividend paying companies, the fund will collect the distributions on its shareholders’ behalf. Depending on the share class held by the investor (distributing or accumulating), the fund will either distribute these dividends to its shareholders or reinvest them back into the fund.
How Much Money Do You Need to Start Passive Investing?
This varies by platform and fund, but passive investing is generally accessible with relatively small amounts. ETFs can be bought for the price of a single share and, depending on the broker, perhaps even less if fractional investing is available.
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