Choosing between a tracker fund and an active fund depends on whether you want to match the market's average return at a low cost or pay higher fees for a professional manager to try and beat that average. Passive tracker funds follow a specific index like the FTSE 100, while active funds are managed by individuals who buy and sell specific assets.
How do tracker funds and active funds differ?
Tracker funds, also known as passive funds, aim to replicate the performance of a specific market index. If the index rises by 5%, your investment should rise by roughly the same amount, minus a very small management fee. These funds do not use human judgement to select stocks; they simply hold everything in the index.
Active funds are run by professional fund managers who aim to outperform a specific benchmark or market index. They use research, economic forecasts, and company analysis to decide which assets to buy, hold, or sell. Because this requires significant human labour and resources, active funds usually charge much higher annual fees than trackers. You are essentially paying for the manager's expertise in the hope that they will deliver better-than-average returns.
Deciding which to use is a core part of personal wealth management. Many investors now use a 'core and satellite' approach. This involves putting the majority of their money into low-cost tracker funds and a smaller portion into active funds where they believe a manager can add specific value.
What are the costs associated with each fund type?
The cost difference between active and passive investing is one of the most significant factors in long-term wealth accumulation. Fees are typically expressed as an Ongoing Charges Figure (OCF), which is the annual percentage of your investment taken by the fund provider.
Tracker funds are generally very cheap because they are automated. You can find many broad market trackers with an OCF between 0.05% and 0.25%. Active funds are considerably more expensive, often ranging from 0.75% to 1.50% or more. While a 1% difference might seem small, it can reduce your final pot by tens of thousands of pounds over 20 or 30 years due to the effect of compounding.
| Feature | Tracker Fund (Passive) | Active Fund |
|---|---|---|
| Primary Goal | Match market index performance | Outperform a benchmark index |
| Typical Annual Fee (OCF) | 0.05% – 0.25% | 0.75% – 1.50% |
| Human Intervention | Low (Automated) | High (Fund Manager) |
| Risk of Underperforming Market | Low (Matches market) | High (Manager may get it wrong) |
| Potential for Market-Beating Returns | None | Possible, though not guaranteed |
Do active funds actually beat the market?
Historical data suggests that the majority of active funds fail to beat their benchmark over long periods. According to various industry studies, including the S&P Indices Versus Active (SPIVA) scorecard, around 80% to 90% of active equity funds underperform their benchmark over a 10-year horizon. This is often because the higher fees create a 'drag' on performance that the manager must overcome just to break even with a tracker.
However, there are specific areas where active management tends to perform better. In 'inefficient' markets—such as emerging markets or small-cap companies—information is less readily available. In these sectors, a skilled manager may be able to find undervalued companies that a generic index tracker might miss. In large, 'efficient' markets like the US S&P 500, it is notoriously difficult for active managers to consistently beat the index.
If you are interested in the theory behind these choices, you can find more detail in our wealth knowledge base. Understanding market efficiency helps in deciding where to deploy your capital for the best risk-adjusted return.
How do I choose which is right for me?
Your choice depends on your personal philosophy, your time horizon, and how much time you want to spend monitoring your investments. If you prefer a 'set and forget' approach with the lowest possible costs, tracker funds are usually the most suitable option. They provide broad diversification and remove the risk that a specific manager will make a poor decision.
Consider active funds if you have a strong conviction about a particular sector or if you are investing in a niche area where professional oversight adds clear value. Some investors also choose active funds for 'downside protection'. During market crashes, an active manager can move to cash or defensive stocks, whereas a tracker fund must follow the market all the way down.
When making this decision, look at these four factors:
- Time horizon: If you are investing for 20 years, small fee differences matter more.
- Risk tolerance: Are you comfortable with the risk of a manager performing significantly worse than the market?
- Asset class: Is the market well-researched (like UK large-caps) or obscure (like Vietnamese tech firms)?
- Simplicity: Do you want to manage a portfolio of individual star managers or one broad global tracker?
For those looking to improve their general financial literacy, our section on personal development covers the discipline required to stick to a long-term investment plan regardless of which fund type you choose.
What are the risks of tracker funds?
The main risk of a tracker fund is 'market risk'. Because the fund must follow the index, it will lose value exactly when the market does. A tracker fund that follows the FTSE 100 cannot sell stocks to avoid a crash; it must hold them as long as they remain in the index. This means your portfolio is entirely exposed to the volatility of the specific market you are tracking.
Another minor risk is 'tracking error'. This is the difference between the performance of the fund and the actual index. It can be caused by the fund's fees, the cost of buying and selling shares, or the method the fund uses to replicate the index. Most modern, high-volume trackers have very low tracking errors, but it is a metric worth checking before you buy.
Is a blend of both strategies a good idea?
Many experienced investors use a combination of both strategies. This is often called a 'Core and Satellite' strategy. You place 70% to 80% of your money in a low-cost, global index tracker (the core). This ensures you get the general market return at a very low price. You then use the remaining 20% to 30% to invest in active funds or specific sectors you believe will outperform (the satellites).
This approach balances the reliability of passive investing with the potential 'alpha' or extra return of active management. It also limits the damage to your overall wealth if your chosen active managers fail to perform. You can read more about building these types of structures in our how-to guides.
Frequently asked questions
Can an active fund be cheaper than a tracker fund?
It is very rare for an active fund to be cheaper than a tracker fund. The operational costs of hiring analysts and fund managers mean active funds almost always have higher fees. While some older, less competitive tracker funds might have higher fees than modern ones, a new tracker will almost always be the lower-cost option.
Are ETFs the same as tracker funds?
Most Exchange Traded Funds (ETFs) are tracker funds, but not all of them. An ETF is simply a fund that you can trade on a stock exchange like a share. While the vast majority of ETFs are designed to track an index, there is a growing market for actively managed ETFs where a manager makes the trading decisions.
What happens to a tracker fund if a company goes bust?
If a company in the index goes bankrupt, the tracker fund will lose the value of its holding in that company. However, because trackers usually hold hundreds or thousands of companies, the impact on your total investment is typically very small. The fund will eventually remove the bankrupt company from its holdings when the index provider removes it from the list.
Which is better for a beginner investor?
For most beginners, a broad market tracker fund is often recommended as the starting point. It offers instant diversification, low fees, and removes the need to research individual fund managers. Once you are comfortable with how the markets work, you might then choose to add active funds to your portfolio for specific reasons.
Do active managers protect you in a market crash?
In theory, active managers can move money into safer assets or cash to protect against a crash. In practice, many active managers are restricted by their fund's rules and must remain fully invested. Data shows that many active funds fell just as much as trackers during previous market downturns, so downside protection is never a guarantee.