Active vs passive investing: what the evidence shows, and why investors keep ignoring it

You can predict the outcome of the active versus passive debate before looking at a single performance chart. It takes one line of arithmetic, and a Nobel laureate wrote it down in 1991. The performance data that has piled up since mostly confirms it. The more interesting question, and the one most comparisons skip, is why so many investors still bet against it.

Active investing is trying to beat a market benchmark by choosing which securities to buy, sell and avoid, usually by paying a fund manager to make those choices. Passive investing is trying to match a benchmark by owning everything in it, in the same proportions, usually through a low-cost index fund or ETF. One accepts the market's return minus a small fee. The other pays more for the chance to do better.

The arithmetic that settles most of the argument

In "The Arithmetic of Active Management", published in the Financial Analysts Journal in 1991, William Sharpe pointed out something that sounds almost too simple to matter. Every dollar in a market is managed either actively or passively. Passive dollars earn the market return, because they hold the market. So the active dollars, taken together, must also earn the market return before costs, since the two groups add up to the whole market.

After costs, the conclusion follows directly. Active management costs more, in fees, research and trading, so the average actively managed dollar must earn less than the average passively managed dollar. Sharpe stressed that this depends only on addition and subtraction, not on any theory about how efficient markets are.

That last point matters. You do not need to believe the efficient market hypothesis to accept Sharpe's argument. Some active managers can be brilliant and prices can be wrong all the time. The arithmetic still says that, as a group, active investors cannot beat passive ones after costs, because every winner's gain relative to the market is matched by someone else's shortfall.

What the arithmetic does not say is that every active fund loses. It says the average one does. Whether you can find the ones that win is a separate, empirical question.

What 25 years of scorecards show

Two long-running studies track this, and they measure it slightly differently. S&P Dow Jones Indices' SPIVA scorecards compare active funds against a benchmark index. Morningstar's Active/Passive Barometer compares active funds against the real index funds and ETFs an investor could have bought instead, fees included. Both correct for funds that closed along the way, which matters, because closed funds tend to be the losers.

According to the SPIVA U.S. Year-End 2025 scorecard, 2025 was the fourth-worst year for active large-cap managers in the report's 25-year history. Its chart of annual results shows only three years, 2005, 2007 and 2009, in which fewer than half of large-cap funds fell short of the index. Outside large caps the picture was less lopsided in 2025, with 55% of mid-cap funds and 41% of small-cap funds underperforming, and bond funds did worse than equity funds, with an average underperformance rate of 70% across categories.

Morningstar's numbers, from its May 2026 analysis of the barometer, measure active funds against real index funds, which carry fees of their own, but the direction is the same. Of 3,140 active funds, 38% survived and beat their average passive peer in 2025. Over a decade the figure falls to roughly one in five. Morningstar also found that long-term success rates were highest among bond and real estate funds, while US large-cap stock funds ranked among the weakest.

Why last year's winner is a poor guide

If roughly one active fund in five beats its passive alternative over ten years, the obvious response is to pick that one. The trouble is that funds rarely stay on top long enough for anyone to spot them in time.

S&P's U.S. Persistence Scorecard for year-end 2025 tracks whether top performers keep performing. With the exception of small-cap funds, none of the top-quartile funds in any reported active US equity category in 2021 stayed in the top quartile through 2025. None.

The shorter-term numbers were better this time. Of the large-cap funds in the top quartile in 2023, 29% stayed there for the following two years, up from 0% in the previous report. But over five years, success looked much like what luck alone would produce, and in some cases worse. S&P's own summary is that consistent outperformance is typically fleeting.

This is the practical problem with active management for an ordinary investor. It is not that skilled managers don't exist. It is that a strong track record, the main evidence you have, predicts surprisingly little about what comes next.

Fees: the one variable you control

If performance is hard to predict, cost is not. It is known in advance, it is charged every year whatever happens, and it compounds.

The Investment Company Institute's 2026 report on fund fees puts the asset-weighted average expense ratio in 2025 at 0.64% for actively managed equity mutual funds and 0.05% for index equity mutual funds. Index equity ETFs averaged 0.14%. Both active and index fees have fallen a long way since the 1990s, but a sizable gap remains.

A gap of 0.59 percentage points sounds trivial. Here is what it does over time, using a simple illustration rather than a forecast: 10,000 dollars invested for 30 years at a 7% annual return before fees.

• At a 0.05% expense ratio, it grows to about 75,100 dollars.
• At a 0.64% expense ratio, it grows to about 63,600 dollars.

That is roughly 11,500 dollars, about 15% less money, lost to fees alone, before the active fund has made a single decision that might go right or wrong. Just to keep up with the index fund, the manager has to outperform by about 0.6 percentage points a year before fees, every year.

Fees also help explain which active funds do succeed. In Morningstar's data, the cheapest fifth of active funds had a 31% success rate over the decade through 2025, against 17% for the most expensive fifth. The same logic runs all the way up to hedge funds, where "2 and 20" fees set an even higher hurdle.

If the evidence is this clear, why does anyone still choose active funds?

The first index fund for individual investors was not an instant success. When John Bogle launched First Index Investment Trust, now the Vanguard 500 Index Fund, on August 31, 1976, he hoped to raise 50 million to 150 million dollars. According to Vanguard's own history, the offering raised a little more than 11 million dollars, and skeptics called it "Bogle's Folly".

It took decades for money to follow the arithmetic. Morningstar reported that flows into US equity funds first favored passive funds in 2005, and that passive funds only overtook active funds in total US fund assets at the end of 2023, 47 years after Bogle's launch. A gap that long is not explained by a lack of data. It is explained by how people think about investing.

Several of the behavioral biases that cost investors money push in the same direction:

• Overconfidence. Many investors believe they are better than average at picking investments, or at picking the managers who pick them. Most of them cannot be.
• Recency bias. A fund that beat the market over the last three years looks like proof of skill, and money flows toward it, even though persistence data says that record predicts little.
• The narrative fallacy. An active manager comes with a story, a thesis, a personality and a reason for every holding. An index fund comes with a ticker and a fee. Stories are more persuasive than base rates.
• Aversion to settling. Accepting the market return can feel like giving up, as though choosing to be average. In reality, after costs, it has beaten most of the people trying to do better.

There is also a quieter commercial reason. Active funds charge more, so there is more money available to pay for marketing and for the advisers who recommend them. The investor pays for that too.

Passive funds do not fix investor behavior

It would be convenient if buying index funds solved the behavioral problem. It does not, at least not automatically.

Morningstar's Mind the Gap 2025 study compares the returns funds earned with the returns their investors earned, once the timing of purchases and sales is taken into account. Over the 10 years through 2024, the average dollar in active funds earned 6.0% a year, about 1.5 percentage points less than the funds themselves returned. Index fund investors did better in absolute terms, earning 8.5% a year, but that still trailed their funds' 9.8% annual return by 1.3 percentage points. Buying high and selling low is possible with any kind of fund.

Those gap estimates are contested. A paper by Jon Fulkerson, Bradford Jordan, Timothy Riley and Qing Yan, published in the Financial Analysts Journal in May 2026, used the same sample and estimated that poor timing costs mutual fund investors only about 0.10% a year, far less than Morningstar's figure. The size of the damage is still being argued over.

The direction is not. A passive fund removes the risk of picking the wrong manager. It does nothing to stop an investor from abandoning it at the bottom of a crash. Morningstar's study found some of the narrowest gaps in allocation funds, such as target-date funds, which rebalance automatically and give investors fewer decisions to get wrong.

Active and passive are a spectrum, not a switch

Most comparisons treat the choice as binary. In practice, funds sit along a line, and some of the most expensive mistakes happen in the middle of it.

At one end is a broad index fund that owns a whole market in proportion to company size. Even that involves decisions: which market, which index provider, and the fact that a market-cap-weighted index holds more of whatever has risen most, so its exposure to the biggest and most expensive companies grows automatically. That is a design choice, not neutrality.

A step along are factor or "smart beta" funds: rules-based and often inexpensive, but deliberately tilted toward characteristics like value, company size, momentum or low volatility. They follow an index, yet choosing the rules is an active bet on which characteristics will be rewarded. Further along are actively managed ETFs, a reminder that the fund wrapper says nothing about the strategy inside it.

Then there is the uncomfortable middle: closet indexing, where a fund charges active fees while holding a portfolio that looks a lot like its benchmark. Martijn Cremers and Antti Petajisto measured this in a 2009 Review of Financial Studies paper using a statistic they called active share, the proportion of a fund's holdings that differs from its benchmark. As summarized by Notre Dame's active share research page, they found that funds with the highest active share outperformed their benchmarks before and after expenses, while non-index funds with the lowest active share underperformed.

That result has been challenged. Andrea Frazzini, Jacques Friedman and Lukasz Pomorski of AQR, writing in the Financial Analysts Journal in 2016, argued in "Deactivating Active Share" that the measure mostly reflects which benchmark a fund uses, and that within a given benchmark, active share was as likely to correlate positively with performance as negatively.

Both sides agree on the part that matters for an investor. A fund cannot beat its index without being different from it, but being different is no guarantee of beating it. Paying active fees for a portfolio that barely differs from the index is the worst of both worlds: you get close to market returns, minus a charge for management you are not receiving.

The case for active management, taken seriously

A fair comparison has to give active investing its best arguments, and some of them are strong.

The deepest one is a paradox described by Sanford Grossman and Joseph Stiglitz in "On the Impossibility of Informationally Efficient Markets", published in the American Economic Review in 1980. If prices already reflected all information, nobody would be paid for gathering it, so nobody would gather it, and prices would stop reflecting it. Markets need some active investors to do the research that makes index funds work. Passive investing is, in a sense, a free ride on that work, and it only stays cheap while enough people are still doing it.

Several narrower points also hold up:

• Some categories give active managers better odds. Morningstar's long-term success rates have been higher for bond and real estate funds than for US large-cap stock funds. In SPIVA's 2025 data, emerging market debt was the one bond category where most active funds beat their benchmark.
• Cheap active funds are a different proposition. The fee data above suggests that a low-cost active fund is a far more reasonable bet than an expensive one.
• Some investors need more than the market return. Specific goals, like avoiding certain industries or managing taxes in a particular way, can require more active decisions than a broad index allows.

None of these overturns Sharpe's arithmetic. They explain why active management still exists, and where it has the best chance of earning its keep.

Where hedge funds fit into this

Hedge funds are active management at its most extreme: the widest freedom to invest, the highest fees, and the least transparency. Warren Buffett's famous ten-year bet, in which an S&P 500 index fund beat a selection of funds of hedge funds, is covered in the guide to what a hedge fund is. It was the same arithmetic, applied at a higher price.

How to weigh the choice

This is general information rather than advice for any particular situation, but a few questions cut through most of the noise:

• What does the active fund cost, and how much would it have to beat its benchmark each year just to match a low-cost index fund?
• Is it in a category where active funds have had decent long-term odds, or one where they have mostly lost?
• Is its record long enough to mean anything, and would you still hold it through several years of trailing the market?
• Whichever you choose, what will stop you from selling at the worst possible moment?

For most investors, the evidence points toward low-cost index funds as the core of a portfolio. The more important lesson from the data is that the choice between active and passive matters less than paying low fees and then leaving the investments alone. The behavioural finance overview explains why that last part is so hard.

Frequently asked questions

What percentage of active funds beat the market?

It depends on the period and the category, but usually a minority. S&P Dow Jones Indices found that 79% of active US large-cap funds underperformed the S&P 500 in 2025. Morningstar found that about one in five active US funds survived and beat the average of their passive peers over the 10 years through 2025.

Is passive investing always better than active investing?

No. Passive investing has won for the average dollar over most long periods, mainly because it costs less, but some active funds do outperform, and long-term success rates have been higher in some categories, such as bond and real estate funds in Morningstar's data. The difficulty is identifying those funds in advance, since past outperformance has been a weak guide to future results.

Are all ETFs passive investments?

No. Most ETF assets are in index funds, 89% at year-end 2025 according to the Investment Company Institute, but actively managed ETFs exist too. Whether a fund is active or passive depends on its strategy, not on whether it is a mutual fund or an ETF.