What is Passive Management?

Passive management, also known as indexing, is an investing method. It isn't dependent on active exposure. It rather aims to mimic a market index. The S&P 500 index is an example of an index that passive management could mimic. With passive management, there are no attempts to profit from market inefficiencies as it is with active portfolio management. Thus, passive management doesn’t rely on subjective human judgments.

The basic premise of passive management is that humans cannot really outperform the market. Instead, they should “go with the flow” of the market. This concept also correlates with the efficient-market hypothesis (EMH). The theory states that current market prices reflect all available data. Thus, it implies that, in the long term, humans cannot outsmart the market.

The primary benefits of passive management include cheaper fees and operating costs. In addition to that, it decreases investing risks. A passive management strategy usually constructs a long-term portfolio. The main task of such a portfolio is to track the performance of a stock market index. Mutual and exchange-traded funds (ETF) are common examples of investment funds that employ this method.

Thus, a much larger market performance affects the success of passive management. Market performance is usually measured with a certain index. Basically, this implies that, when it comes to asset selection, human error isn't a problem with passive management. Besides, due to their reduced expenses, passive portfolio management solutions usually outperform active management.