Should you pay a professional to pick stocks for you, or simply buy the whole market and pay almost nothing? That question — active versus passive investing — is one of the most researched debates in finance, and the evidence increasingly favours the cheaper option. This explainer covers how index funds work, what the performance data actually shows, and where active management might still earn its keep.

What an index fund is

An index fund is a mutual fund or exchange-traded fund (ETF) that tracks a market index — such as the Nifty 50, the S&P 500 or a bond index — by holding the same securities in roughly the same proportions. Instead of a manager betting on winners, the fund simply replicates the index, rebalancing when the index adds or removes companies.

There is no stock-picking, so costs stay low: the annual expense ratio — the fee deducted daily from the fund’s assets — is typically a fraction of a percent for index funds, compared with around 1% or more for actively managed funds. Index funds come in several flavours: broad-market funds tracking major indices, international funds, sector funds, and bond funds used for income and stability. Dividends paid by the underlying stocks flow into the fund, and the value of each unit is calculated once daily as the Net Asset Value (NAV).

What active investing promises

Active investing is the traditional model: a fund manager and their analysts research companies, build concentrated portfolios and try to beat the market index. The pitch is that skilled professionals can avoid losers, spot winners early and protect you in downturns. The catch is the fee: active funds charge far more, because research teams and frequent trading cost money. For active management to be worth it, the manager must outperform the index by more than the fee gap — year after year.

The scoreboard: what SPIVA shows

The most cited evidence comes from the SPIVA scorecards published twice a year by S&P Dow Jones Indices, which compare actively managed funds against their benchmarks while adjusting for survivorship bias (including funds that were merged or shut down during the period).

The year-end 2024 US scorecard found that among large-cap funds, 65.2% underperformed the S&P 500 over one year, 76.3% over five years and 84.3% over ten years. Over fifteen years, large-cap underperformance exceeded 90%. The pattern held across categories: 85.3% of international funds lagged their benchmark over ten years, and 87.4% of emerging-market funds did the same. In other words, the longer the horizon, the harder it gets for active managers to keep up — and the scorecard’s authors note that over the 15-year period, no equity or fixed-income category showed majority active outperformance.

Why costs are the quiet killer

The main explanation is arithmetic, not incompetence. Markets are roughly efficient enough that the average active fund, before fees, performs about like the market itself — and after fees, it trails. A widely cited illustration: an index fund charging around 0.04% a year versus an active fund charging 1% or more. Over decades, that gap compounds relentlessly, eating a large share of an investor’s returns.

Index funds aren’t perfect mirrors of their indices either. The gap between a fund’s return and its benchmark is called tracking error, and it arises from the fund’s own expenses, small cash holdings kept for redemptions, and the timing differences when indices rebalance. Lower tracking error means the fund follows its index more faithfully — which is why investors are advised to compare both expense ratio and tracking error when choosing between index funds.

The other side: when active may still help

The case for indexing has nuances worth knowing. Researchers Cremers, Fulkerson and Riley (2026), covered by Morningstar, argue that SPIVA’s fund-counting method understates active managers: when they weighted funds by assets rather than counting each fund equally and adjusted for dead funds, only about 63% of active US equity assets lagged their benchmark over ten years — closer to a coin flip for the average dollar invested. The debate over methodology is live and unresolved.

Active funds also tend to fare better in less efficient corners of the market. In the year-end 2024 scorecard, only 29.7% of active small-cap funds underperformed over one year — far better than the large-cap figures — suggesting that skilled managers may add more value where information is scarcer and fewer analysts look. Niche markets, distressed debt and concentrated special-situations strategies are other areas where active advocates claim an edge.

A practical starting point

For most long-term investors, the evidence points to a simple default: a low-cost, well-diversified index fund as the core holding. When comparing index funds, check the expense ratio and the tracking error (from the fund house’s own documents), prefer funds with a long history of hugging their benchmark, and remember that past performance — of any fund, active or passive — guarantees nothing. Active funds can play a supporting role in specialised areas, but the burden of proof is on their fees: they need to beat the index by more than they charge, consistently, and most don’t.

FAQs

Do active funds ever beat index funds?

Yes — in any given year, a meaningful minority of active funds outperform. The SPIVA data shows this is most common in less efficient segments like small-cap stocks. The difficulty is identifying those outperformers in advance and holding them long enough, since most lag over multi-year periods.

Compiled by the Khabar 24h Editorial Desk from publicly available sources.