Active vs. Passive ETFs

Now that you understand the core ETF structure, let's look at the two management approaches: passive (index) and active.

Think of it this way: A passive ETF is on autopilot, following an index's rules mechanically. An active ETF has a pilot making real-time decisions, trying to find a better route. Autopilot is cheaper and more predictable; a pilot costs more but might find shortcuts.

Passive (Index) ETFs

• Track a benchmark index (S&P 500, bond indices, sector indices)
• Goal is to match the index return, not beat it
• Very low expense ratios - as low as 0.03%
• Minimal portfolio turnover - only trades when the index changes
• The vast majority of ETFs are passive

Common index ETF examples:

• S&P 500 index ETFs
• Nasdaq 100 index ETFs
• Russell 2000 (small-cap) index ETFs
• Total bond market index ETFs

Exam Tip: Gotchas

• Passive ETFs aim to match the index, not beat it. If a question uses "outperform" language, that points to active management.

Active ETFs

• A portfolio manager actively selects securities to try to outperform a benchmark
• Higher expense ratios than passive ETFs (but generally lower than actively managed mutual funds)
• May have higher portfolio turnover (and potentially more taxable events)
• A growing category, but still a small fraction of total ETF assets

Exam Tip: Gotchas

• Active ETFs still have lower expense ratios than actively managed mutual funds. The ETF structure itself keeps costs down, even with active management.
• Higher turnover in active ETFs can reduce their tax efficiency advantage over mutual funds compared to passive ETFs.

Side-by-Side Comparison

Exam Tip: Gotchas

• Most ETFs are passively managed index funds. When a question refers to "ETFs" without specifying, assume it means a passive/index ETF. Active ETFs exist but are less common and carry higher fees.