Active vs. Passive Funds: Performance in 2025 & How to Choose | CNBC

The debate between active and passive investing continues, with recent data revealing a nuanced picture. Whereas passive funds generally maintain a cost advantage, the performance gap between active and passive strategies is narrowing in certain areas, according to a recent Morningstar report. Understanding these shifts is crucial for investors seeking to optimize their portfolios.

In 2025, 38% of actively managed mutual funds and exchange-traded funds outperformed their index-based counterparts, a slight decrease from 42% in 2024. Though, this headline figure masks significant variations across investment categories. Areas like emerging markets saw a substantial increase in active fund success, with 64% beating their passive peers – a 42 percentage point jump from the previous year. This suggests that active management can add value in less efficient markets.

Passive funds, which track a specific index, remain a cornerstone of many investment strategies, particularly for broad market exposure. Their low expense ratios – averaging 0.135% for ETFs and 0.058% for mutual funds at the end of 2025 – are a significant advantage, especially over the long term. As Mike Casey, founder and president of AE Advisors in Alexandria, Virginia, puts it, “I don’t treat passive and active [funds] as rivals. I treat them as teammates.”

The impact of fees on investment returns cannot be overstated. The Securities and Exchange Commission illustrates this with a simple example: an investor starting with $100,000 earning 4% annually would have approximately $208,000 after 20 years with a 0.25% fee, compared to $179,000 with a 1% fee – a difference of $29,000. This underscores the importance of minimizing costs, particularly when utilizing passive strategies for core holdings.

Active fund managers can potentially “add real alpha” – returns exceeding the benchmark – in less efficient segments of the market. However, the Morningstar report highlights that only 31% of active funds in the cheapest quintiles of their categories beat their average passive peers over a 10-year period, compared to 17% for the priciest funds. This reinforces the importance of cost-consciousness even when selecting active strategies.

Investment strategies should evolve alongside an investor’s life stage. For younger investors in their 30s or 40s, a portfolio primarily composed of passive funds can provide a solid foundation. However, as retirement approaches, the need for risk management increases. As CFP Patrick Huey of Victory Independent Planning notes, “The closer you get to retirement, the more it begins to matter because you just can’t accept the volatility of the general index.”

Active management may be particularly valuable in bond funds as retirement nears. Active bond managers can adjust portfolio duration, raise cash, or adopt defensive positions in response to changing market conditions. While 40% of active bond funds outperformed their passive counterparts in 2025 (down from 64% in 2024), they still boast a 42% success rate over 10 years, exceeding all other categories tracked in the report.

Several trends are likely to shape the future of active and passive investing:

• Increased Focus on ESG Factors: Environmental, social, and governance (ESG) considerations are gaining prominence, potentially creating opportunities for active managers to identify undervalued companies with strong ESG profiles.
• The Rise of Factor-Based Investing: Factor-based ETFs, which target specific investment characteristics like value or momentum, may offer a middle ground between passive and active strategies.
• Technological Advancements: Artificial intelligence and machine learning are being increasingly used in portfolio management, potentially enhancing the capabilities of both active and passive funds.

Q: Is active or passive investing better?

There’s no single answer. It depends on your investment goals, risk tolerance, and time horizon. A combination of both can be optimal.

Q: What are expense ratios and why do they matter?

Expense ratios are the annual fees charged to manage a fund. Lower expense ratios signify more of your investment returns stay with you.

Q: What is alpha?

Alpha is the excess return of an investment relative to its benchmark.

Q: When should I consider active management?

Active management may be beneficial in less efficient markets or when seeking to manage risk more actively, particularly as you approach retirement.

Pro Tip: Regularly review your portfolio allocation and rebalance as needed to ensure it aligns with your evolving financial goals.

Want to learn more about building a diversified investment portfolio? Explore our other articles on personal finance.