How To Define Passive Investment

Recently, I heard Nobel Prize-winner and finance professor Eugene Fama define “active management” as any fund that engages in security selection and/or market timing. And actively managed funds are fairly easy to identify. As we know, the term “passively managed” is used to describe the opposite of actively managed. But what, exactly, is meant by passively managed?

Given that there’s so much discussion surrounding this subject, I thought it worthwhile to describe how I answer that question. We’ll first provide my requirements for a fund to be considered passive. Then we’ll discuss some additional criteria you should use before you consider investing in a passively managed fund.

We’ll begin by stating that once you make a decision to deviate from owning a total market fund, you are making an active decision, and you should have good reasons for making that choice. But it is possible to find and invest in a passively managed fund that isn’t also a total stock market fund.

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