Index Funds vs Actively Managed Funds: Why Passive Wins

Yes, for most people index funds are the better choice. Actively managed funds pay a fund manager to try to beat the market, but after their higher fees most of them don't. Over the 10 years to the end of 2025, S&P's SPIVA research found that 86% of US large-cap active funds, 95% of UK large- and mid-cap funds and 94% of South African equity funds trailed their index. An index tracker simply owns the whole market at a fraction of the cost. That's why my KISS core investing strategy (keep it simple, sexy and safe) is built on index trackers.

This guide is part of my complete guide to investing in index funds.

What's the difference between index funds and actively managed funds?

An actively managed fund has a manager or team choosing which shares to buy and sell, aiming to beat the market. An index fund, or index tracker, has no one choosing: it buys every company in a set index, such as the FTSE All-Share or the S&P 500, in the same proportions, and simply mirrors it.

That's why index funds are called passive funds. Don't let the word fool you: passive describes how the shares are selected, not how they perform.

If you're new to trackers, start with what an index tracker is and why you should care.

Do actively managed funds beat index funds?

Most don't, and the longer you look, the fewer do. In any one year a decent share of active funds may come out ahead, but over 10 and 20 years the large majority fall behind the index they're trying to beat.

The best long-running scorecard is S&P Dow Jones Indices' SPIVA research, which compares active funds with their benchmark index in each region. Here's what its latest full-year reports found, for the period to 31 December 2025:

Sources: SPIVA U.S. Year-End 2025, SPIVA Europe Year-End 2025 and SPIVA South Africa Year-End 2025. Figures rounded.

This isn't new. In the 1970s John Bogle, who went on to found Vanguard, found that most fund managers weren't beating the market, and asked why anyone should pay them. That question gave birth to the index tracker.

The funds that disappear

The real picture is even less flattering, because many active funds close or merge when they do badly. SPIVA found that only about 35% of US large-cap funds survived the full 20 years, and only 41% of UK large- and mid-cap funds survived 10.

Why most active funds fall behind: the three hidden costs

Active funds fall behind mainly because of cost, not because the companies they buy are bad. Their gross returns can be close to the market's, but three layers of cost come off the top before you see a penny, and compounding magnifies every one of them.

1. The people. Fund managers, analysts and their salaries, bonuses and perks are paid from your investment. In my trainings I talk about how the industry celebrates the star fund manager, and it's your money that pays for the lifestyle.
2. The institution and its advertising. Think of the banners you walk past at the airport, inviting you to trust a fund house with your pension. Your money pays for those too.
3. The churn. Active funds buy and sell more often, partly to look busy. Every trade has dealing costs, and in taxable accounts, potentially more tax.

Here's how I explain it. If you put in $100 and 5% in fees comes off the top, only $95 is working for you. "But Ann, what's 5%?" It's that money, plus everything it would have grown into, for as long as you're invested.

The gap in fees is real. In the US, Morningstar's 2026 fund fee study found the asset-weighted average active fund cost 0.57% a year in 2025, against 0.09% for broad index funds. Advice and platform charges come on top of these.

What fees cost you: a worked example

Small differences in yearly fees grow into big differences in what you end up with. Over 30 years, the gap between a low-cost index tracker and an expensive active fund can be worth more than half of everything you paid in.

Say you invest £200 a month for 30 years, and the market returns 7% a year before costs in every case. This is an illustration of how fees compound, not a prediction or a recommendation.

You paid in £72,000 in every case. The difference between the cheapest and the most expensive is about £47,700, which is two-thirds of everything you contributed, gone in fees. And that assumes the active fund matched the market. Most, as you've seen, don't.

The percentages work the same in dollars, euros or rand. This is why cost is the first of my 3 C's of investing success: cost, consistency and contributions. They're the three things you control, whatever the market does.

Why index funds win more often than you'd expect

Index funds win because the market's average return is already excellent, and a tracker gives you all of it, minus a sliver of cost. You don't need to be cleverer than the market. You just need to own it, cheaply, and stay put.

There's a second reason I love trackers. An index automatically brings in the rising stars and drops the companies that are fading. So you're always holding the cream of the crop, without anyone having to guess which company will be next year's winner. Boring is beautiful.

Warren Buffett, one of the most successful active investors in history, has said much the same. I unpack his view in why Warren Buffett recommends you invest in index funds.

When can an active fund earn its place?

Active funds have a better record in smaller, less-researched corners of the market, such as smaller companies and some emerging markets. Even there, the evidence is mixed from year to year, so they belong around a low-cost core, not instead of it.

In 2025, for example, SPIVA found only 41% of US small-cap active funds underperformed, a much better showing than large caps. And as MoneyWeek's review of active versus passive notes, the active managers who add value tend to be found where fewer analysts are looking.

The catch is that nobody can reliably pick tomorrow's winning managers in advance. That's why I teach a core index tracker portfolio first, which you can read about in how many index funds you need. Anything else you choose to add should complement that core, never replace it.

Five questions to ask before you pay for active management

• What is the total yearly cost, including the fund charge, any adviser fee and the platform fee?
• How has the fund done against its index, after fees, over 10 years, as well as the last one?
• Is it doing something an index tracker can't, or is it mostly holding the same big companies?
• Can I see what's inside it? I call this WISIWYG: what's inside is what you get.
• What would it cost me to leave: exit fees, or tax on gains outside a tax-free account?

How to check what you're paying where you live

Every fund publishes its yearly charge, but the name differs by country. Add any platform and adviser fees to see your true total.

• UK: look for the ongoing charges figure (OCF) on the fund's key information document, plus your platform fee and any adviser charge.
• US: look for the expense ratio in the fund's prospectus or fact sheet, plus any advisory fee.
• South Africa: look for the total expense ratio (TER) and the total investment charge (TIC) on the fund's minimum disclosure document, plus platform and adviser fees.
• Living abroad: expat savings plans and offshore bonds can stack several charges. Ask for every one in writing.

If an adviser is part of your picture, my guide on how to choose a financial advisor who puts you first covers the questions to ask about fees.

Questions people ask

Do any active funds beat index funds?

Yes, some do in any given year, and a small number do over long periods. The difficulty is picking them in advance, because past winners rarely stay on top, and you pay higher fees in every year whether they win or not.

Are index funds safer than actively managed funds?

Not in the sense of avoiding falls. An index fund goes down when its market goes down. What it removes is manager risk, the risk that someone's choices and fees leave you trailing the market for years.

Should I move from active funds into index funds?

That depends on your own situation. Before moving anything, check exit fees, tax on gains outside tax-free accounts and any guarantees you could lose. Often the simplest first step is pointing new contributions at low-cost trackers.

Learn how I build my index tracker portfolio

If you'd like to see exactly how I choose low-cost trackers, design a core portfolio and put it on autopilot, join my free How to Be a Successful Investor masterclass. It's a 90-minute training, and I walk you through the whole recipe.

Register for the free How to Become a Successful Investor masterclass

When you're ready to build your own portfolio with me, step by step, my Savvy Investor programme takes you from opening your platform to a fully designed, automated index tracker portfolio. You'll hear all about it in the masterclass. And for the full Expand Your Dough recipe, it's all in The Wealth Chef book.

This article is for education only and isn't financial advice.

Written by Ann Wilson, founder of The Wealth Chef and author of The Wealth Chef and Break Free Forever. Debt-free since 1994 and financially free since 2006.