The Future of Passive Investing
Passive funds have gone from fringe idea to nearly half the market in a generation. The big questions now are about fees near zero, direct indexing, and whether indexing can get 'too big'.
Don't have time? Here's what you need to know:
- 1Passive funds have grown from 'Bogle's Folly' in the 1970s to rivaling or surpassing active U.S. equity assets today, driven by decades of SPIVA evidence.
- 2Core index ETF fees have collapsed from ~0.20%+ to ~0.03% (some at zero), so the fee war on plain funds is effectively over.
- 3Direct indexing is the main new frontier, most useful for tax-loss harvesting in large taxable accounts, but it adds complexity most investors don't need.
- 4Worries that indexing is 'too big' are mostly overstated: active managers still set prices at the margin, and the low-cost, diversified core endures.
From Fringe Idea to Nearly Half the Market
When John Bogle launched the first index fund in the 1970s, critics nicknamed it "Bogle's Folly" — the idea that you would settle for the market's return instead of trying to beat it struck the industry as absurd. A half-century later, passively managed funds have grown to rival, and by some measures surpass, the assets held in active U.S. equity funds. The folly won.
That shift was driven by evidence, not fashion. Decades of SPIVA data showing roughly 85-90% of active funds trailing their benchmark over long horizons made the case impossible to ignore, and the money followed. The question now is not whether passive investing works — that argument is largely settled — but where it goes from here as fees approach zero and the tools evolve.
Fees Have Fallen as Far as They Can Go
The most visible trend has been the collapse in costs. Broad index ETFs that once charged 0.20% or more now routinely cost 0.03-0.04%, and a few funds have been offered at zero expense ratio as loss-leaders. On a practical level, the fee war is essentially over for the core building blocks: at three basis points, the difference between the cheapest funds is a rounding error.
This is unambiguously good for investors, but it changes how providers compete. With management fees near zero on plain index funds, issuers increasingly make money elsewhere — securities lending, cash management, and higher-fee specialty products — and compete on brand, tax efficiency, and ancillary services rather than headline cost. For the investor building a simple portfolio of VTI, VXUS, and BND, the takeaway is simple: cost has already been wrung out, so chasing the last fraction of a basis point is not where your attention belongs.
| Era | Typical broad-index ETF expense ratio |
|---|---|
| 1990s | ~0.20%+ |
| 2000s | ~0.10-0.15% |
| 2010s | ~0.03-0.05% |
| Today | ~0.03% (some at 0.00%) |
Direct Indexing and the Next Phase
The most discussed frontier is direct indexing: instead of buying a fund that holds the index, you own the underlying stocks directly in your own account, replicating the index while keeping the flexibility to customize. The appeal is twofold — you can harvest tax losses on individual positions even when the index is up, and you can tilt or exclude holdings to match values or avoid over-concentration in a stock you already own through your employer.
Falling trading costs and fractional shares have made direct indexing feasible for ordinary investors, not just the wealthy, and providers are pushing it hard. It is genuinely useful in large taxable accounts where tax-loss harvesting can add a bit of after-tax return. But it adds complexity, and for most people a plain index ETF in a tax-advantaged account captures the great majority of the benefit with none of the fuss. Direct indexing is an evolution of passive investing, not a replacement for it.
Tip: Direct indexing mainly pays off in a sizable taxable account where automated tax-loss harvesting can offset other gains. In an IRA or 401(k), where gains aren't taxed annually, a simple low-cost index fund usually wins on simplicity.
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Can Passive Investing Get 'Too Big'?
As indexing has grown, so have worries about it. One concern is price discovery: if everyone just buys the index, who does the work of setting fair prices? In practice, active managers still trade enormous volumes and set prices at the margin, and passive ownership remains a minority of actual trading activity even where it is a large share of assets. The system that indexing depends on is not, by most evidence, in danger of seizing up.
A second concern is the concentration of corporate voting power in a few large fund families, which is a legitimate governance question regulators continue to examine. None of this changes the case for an individual investor: owning the market cheaply is still the highest-probability path to long-term returns. The future of passive investing is less about whether the strategy works and more about refinements at the edges — customization, tax efficiency, and governance — while the simple core endures.
Important: Be wary of products marketed as 'the next evolution beyond indexing' that quietly reintroduce high fees or active bets. The enduring edge of passive investing is low cost and broad diversification; anything that sacrifices those is moving away from the strategy, not advancing it.
Frequently Asked Questions
Will passive investing keep working as it gets more popular?
By the available evidence, yes. Even as indexing has grown to rival active assets, active managers still trade huge volumes and set prices at the margin, so markets continue to function. For an individual investor, the core advantages — broad diversification and very low cost — do not erode just because more people share the strategy. The arithmetic that makes the average passive dollar beat the average active dollar after fees still holds.
What is direct indexing and should I use it?
Direct indexing means owning the individual stocks of an index in your own account rather than buying a fund, which lets you harvest tax losses on individual positions and customize holdings. It is most valuable in large taxable accounts where tax-loss harvesting can add after-tax return. For most investors, especially in tax-advantaged accounts, a simple low-cost index ETF captures the bulk of the benefit with far less complexity.
Are index fund fees going to keep falling?
There is very little room left to fall. Core broad-market ETFs already charge around 0.03%, and a handful have been offered at zero. The fee war on plain index funds is essentially over, so future competition is shifting toward tax efficiency, customization, and services rather than headline expense ratios. Chasing the last fraction of a basis point is no longer where investors should focus.
Is it true that index funds are distorting the market?
The concern is largely overstated. While passive funds hold a large share of assets, they account for a minority of actual daily trading, and active managers still set prices through their buying and selling. There are legitimate, more nuanced questions about the concentration of voting power among a few large fund families, which regulators continue to study, but the basic mechanism of price discovery remains intact.
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Alex Harrington
CFA Level II Candidate, Finance & Economics
Alex Harrington is an independent ETF researcher and personal finance writer with over 8 years of experience analyzing exchange-traded funds. A CFA Level II candidate with a background in economics, Alex has reviewed 800+ ETFs and helped thousands of beginners build their first investment portfolios through clear, jargon-free education.
This content is for educational purposes only and does not constitute financial advice. Past performance does not guarantee future results. Consult a licensed financial advisor before making investment decisions.