Certified Plan Sponsor Professional (CPSP) Practice Exam

What is the key difference between active and passive mutual funds?

1. Active funds are less expensive than passive funds.

2. Active funds seek to outperform an index benchmark while passive funds seek to match index benchmark returns.

3. Passive funds provide more personalized investment strategies.

4. Passive funds require frequent trading compared to active funds.

The correct answer is: Active funds seek to outperform an index benchmark while passive funds seek to match index benchmark returns.

The distinction between active and passive mutual funds primarily revolves around their investment strategies and objectives. Active funds are managed by portfolio managers who make deliberate decisions about buying and selling securities in an effort to outperform a specific benchmark index. This active management approach aims to generate higher returns than the market average by capitalizing on market inefficiencies. On the other hand, passive funds are designed to replicate the performance of a specific index, such as the S&P 500. They achieve this by investing in the same securities that constitute the index in the same proportions, thereby seeking to match the index's returns rather than exceeding them. This fundamental difference in objectives is what sets the two types of funds apart; active funds strive for superior performance, while passive funds aim for performance that mirrors a benchmark. Considering the other options, active funds are generally more expensive due to higher management fees associated with the active strategies, which is contrary to what one would find with passive funds. Regarding personalized investment strategies, passive funds do not typically offer these, as their goal is to adhere strictly to the index. Lastly, passive funds are associated with lower trading frequency, as their strategy involves minimal adjustments to maintain index alignment, which opposes the higher trading activity typically seen in active funds.