Definition
The term passive fund refers to a portfolio of securities that are thought to mirror a market index such as the S&P 500. The objective of passive funds is to find securities that will provide investors with a return equal to the index that the fund's managers are attempting to replicate.
Explanation
Also known as a passively managed fund, the objective of a passive fund is to provide investors with a return that is equal to the market index the fund attempts to replicate. This is accomplished by constantly balancing the equities in the portfolio. Individuals that invest in passive funds believe in the efficient market hypothesis, which states the current market price of a security fully reflects all of the available information.
While the ability to beat the market is appealing to many investors, a number of studies conclude index funds (passive funds) outperform between 75% and 90% of active funds. Investors choosing passive funds should have average risk tolerance scores, since the fund's management team will be attempting to match the return of a broader market index, which should exhibit average risk and volatility.
Related Terms
active funds, fund of funds, asset allocation fund, go-go funds
