With active ETFs exploding in complexity and capturing almost half of all ETF inflows in recent years, the traditional “passive vs. active” debate has evolved into a more nuanced discussion about when and how to deploy each strategy for optimal client outcomes.
As a result, it’s more important than ever for your clients to understand the differences between active and passive ETFs. Below, we gathered expert advisors to discuss what you should teach them, as well as talking points and decision frameworks you can use to help align their ETF investment choices with their goals and preferences.
Key Takeaways
- Passive ETFs automatically track an index or benchmark, while active ETFs are run by managers who try to outperform the market or achieve certain outcomes.
- Passive ETFs tend to have lower expense ratios, offer greater transparency, and provide slightly higher tax efficiency than active ETFs.
- Most active ETF managers fail to consistently outperform passive ETFs over the long term, but they may achieve short-term outperformance, particularly during volatile market conditions.
- Advisors should help clients balance passive and active ETFs in their investment portfolios based on their goals, risk tolerance, and investment preferences.
Defining the Difference
When discussing ETFs with clients, first clarify the distinction between passive and active versions of the funds.
Passive ETFs track the performance of a specific index with minimal human intervention. They automatically hold the same securities in about the same proportions as their underlying benchmark.
You can use Vanguard S&P 500 ETF (VOO), one of Vanguard’s leading passive ETFs, as an example. It tracks the S&P 500 Index, providing exposure to the 500 largest U.S. companies and mirroring the index’s returns as closely as possible.
In contrast, active ETFs are managed by an expert or a team of experts whose primary goal is typically to outperform a specific benchmark or achieve a particular investment aim. These managers make ongoing decisions about what securities to buy, sell, and hold.
The BlackRock Equity Dividend Fund (BDJ) is a good example: an active ETF focused on beating the Russell 1000 Value Index. Its managers curate a mix of high-quality, dividend-paying companies in the U.S. to provide lower volatility equity returns.
“Passive ETFs typically track indexes that pursue rules-based strategies,” said Aaron Brask, PhD, Principal at Aaron Brask Capital. “Meanwhile, active ETFs are based on the discretionary decisions of one or more portfolio managers.”
Cost, Transparency, and Tax Efficiency
Beyond the theoretical separation between active and passive ETFs, clients need to understand the practical differences that should inform their preference for one or the other.
Costs
Because passive ETFs track an index or benchmark automatically, they generally require less day-to-day management, often resulting in lower expense ratios. For example, Vanguard’s VOO has an expense ratio of 0.03%. This means that for every $10,000 a client invests in the passive ETF, their annual costs will be $3.
In contrast, active ETFs require much more hands-on management, typically resulting in higher expense ratios. For example, BlackRock’s BDJ has an expense ratio of 0.88%, which translates to an annual cost of $88 per $10,000 invested.
Tip
If a client invested $100,000 and let it grow 7% annually for 20 years with no further contributions, an ETF with an expense ratio of 0.03% would cost them $2,164.15. Meanwhile, an ETF with an expense ratio of 0.94% would cost $62,604.59.
Transparency
Passive ETFs tend to be transparent about their guiding principles and investment holdings, disclosing the latter daily. This ensures that clients can always determine exactly what’s going on with the fund’s underlying assets.
Active ETFs are allowed to be less forthcoming about the details of their strategy. After all, their managers are trying to outperform the market and beat their competitors. They may disclose their holdings less frequently, making it harder for clients to determine what they own at any given point.
Important
It’s worth noting that these are generalizations about active and passive funds, not hard-and-fast rules. Some advisors find the labels unhelpful. “I tell clients to ignore the active vs. passive label,” said Carson McLean, founder and CFP at Altruist Wealth Management. “Instead ask: Is it predictive or systematic? Is it diversified, low-cost, transparent, and backed by evidence?”
Tax Efficiency
One of the advantages of ETFs—whether passive or active—over mutual funds is their increased tax efficiency. In addition to being traded on exchanges, ETFs support a unique method of buying and selling shares using creation units. This minimizes capital gains within the funds, which are taxable events.
That said, passive ETFs still tend to be more tax-efficient than active ETFs. This is because their strategies require less turnover and involve fewer taxable transactions. After all, they only adjust their holdings when their underlying index changes, while active ETF managers trade more frequently in pursuit of outperformance.
“Many people assume that the tax benefits of ETFs stem from the underlying indexes having low turnover,” said Brask. “However, it is the ETF structure and the way they can create and redeem shares that allows them to be tax-efficient.”
Performance Expectations and Misconceptions
Once clients understand the fundamental differences between active and passive ETFs, help them develop realistic return expectations for each type. That primarily means teaching them that passive ETFs tend to outperform over the long term.
“Active ETFs solve for tax inefficiency relative to active mutual funds, but not for underperformance,” McLean said. “A predictive strategy in an ETF wrapper is still a predictive strategy, and the data is clear. According to SPIVA, every equity asset class saw more than 88% of managers underperform their benchmark over the 15-year period ending in 2024.” The overall data for active and passive funds is below.
The broadening knowledge of this data has, over the long term, contributed to the popularity of passive index investing in the U.S. In May 2025, the combined assets under management (AUM) of indexed mutual funds and ETFs increased $826.85 billion to $16.79 trillion, while the AUM of active funds rose by just $585.42 billion to $15.88 trillion. Yet, while the long-term trend has favored passive investing—growing from 19% to over 50% of assets since 2010—the recent explosion of active ETFs suggests this dynamic may be shifting.
As such, clients should understand that active ETFs can still play a significant role in diversified portfolios. While they may lag the market on average, some skilled managers can outperform with specialized strategies meant for periods of volatility.
How To Guide Your Conversations With Clients
Once your clients have a good grasp on the differences between passive and active ETFs, as well as the strategic pros and cons, they should be well-equipped to discuss building their portfolio. You can feel out their priorities by asking questions like the following:
- What are your investment goals (long-term growth, income, etc.)?
- Are you looking for broad market exposure or targeted prospects?
- How involved do you want to be in monitoring your portfolio’s performance?
Consider also providing them with a simple framework. “To create an ideal model portfolio for clients, we use a core/satellite approach,” said Stuart Schiffman, CFP, ChFC, founder of Compound Wealth Advisors. “For core, we use the S&P 500, such as VTI, and then we add on satellite positions for diversification. The satellite positions can be active or rules-based ETFs that have shown to add alpha.”
For example, suppose your client believes the semiconductor sector will outperform over the next decade. In that case, you might advise them to take a small position in an actively managed semiconductor ETF in addition to their core passive holdings.
Michael Martin, vice president of market strategy at TradingBlock, uses a similar approach. “I keep about 90% of my portfolio in passive ETFs and 10% in active ETFs. I use passive ETFs for broad market exposure, where benchmarks are well established and fees are low. My active ETF positions are usually in sectors where there isn’t yet a solid benchmark or where I have high conviction that the sector will outperform.”
How Should I Explain Whether Active or Passive ETFs Are Better for a Specific Client?
Explain that whether active or passive ETFs are better depends on a client’s goals and preferences. Generally, passive ETFs are more suitable for long-term investors looking for broad, low-cost market exposure. Meanwhile, active ETFs might be better for those seeking short-term outperformance or niche exposure.
How Do I Justify the Higher Fees of Active ETFs to Cost-Conscious Clients?
If minimizing fees is a client’s priority, don’t try to justify the higher fees of active ETFs. Keeping costs low is a valid strategy, and passive ETFs may simply be a better fit for them. However, you can explain that the increased cost of active ETFs may be worth it when they can provide enough alpha.
How Do I Address Client Concerns That Active ETFs Might Be Riskier?
Acknowledge that active ETFs introduce performance risk—the potential to underperform their benchmarks—but explain that they aren’t inherently riskier than passive ETFs. Their risk profile depends on the manager’s strategy and the ETF’s objectives. For example, some active ETFs are conservative, prioritizing income or capital preservation.
The Bottom Line
Passive ETFs offer cost efficiency, transparency, and long-term performance advantages, often making them a better core holding for client portfolios. However, active ETFs can add value by providing opportunities to profit from skilled managers who can outperform in the short term, especially in volatile or inefficient markets.
You can help clients balance passive and active ETFs in their investment portfolios by discussing their goals and risk tolerance, then tailoring your recommendations to their personal needs and preferences.