Perhaps one of the longest-running debates in the investment industry is the so-called “active vs. passive” debate.

Most people understand it this way: Will active managers who pick stocks (or bonds) fare better than index funds? The industry of stock-pickers says yes; the index fund companies say no way.

The name “passive” is just terrible. It sounds like nobody is doing anything, when in fact index investing is a reflection of all investors’ collective decisions.

Indexes aren’t natural phenomena—they are designed, maintained, and rebalanced based on rules and judgments. There’s nothing passive about the work that goes into creating and maintaining them.

Many studies show that, on average, index funds fare better than active managers. But in any given period, there are always some managers who under- or outperform. Underneath this debate is a bigger question: whether markets are efficient.

The Efficiency Question

The Efficient Markets Hypothesis (EMH), first proposed by Professor Gene Fama of the University of Chicago, argues that asset prices quickly and fully reflect all known information.

A corollary of the theory is that it will be extremely difficult for anyone to consistently outperform the market, since today’s prices already incorporate what’s known about every stock and bond.

This doesn’t mean nobody will ever beat the market—only that it’s unlikely to be consistent over time. Of course, anomalies like momentum show that markets aren’t perfectly efficient, but the EMH still set the intellectual backdrop that fueled index investing.

Where the Language Breaks Down

Despite this long history, the labels “active” and “passive” are increasingly unhelpful.

Consider Dimensional Fund Advisors (DFA): their portfolios are built on systematic rules, tilting toward factors like size or value. They don’t make discretionary stock picks, yet for regulatory reasons, their ETFs are classified as ‘active’ because they don’t track indexes.

At the other end is the S&P 500, the king of all indexes. It’s actively managed by a committee that decides what companies to add and subtract, and when. As a group, they’ve made some pretty bad calls over the years. One example is their much-criticized delay in adding Tesla, which by the time it entered was already one of the largest companies in the world.

A Better Lens: Cost and Discretion

Rather than clinging to the old vocabulary, it’s time to reframe the debate around two dimensions that matter more to investors:

• Low-Cost, Systematic (Rules-Based, Quantitative): Strategies grounded in transparent rules, implemented consistently, usually at very low cost. This includes index funds, ETFs, and factor-based strategies.

• High-Cost, Discretionary: Strategies where managers make judgment calls about securities, sectors, or timing, typically at higher cost. This is traditional stock-picking, tactical allocation, and most hedge-fund-like approaches.

Words shape how investors think. The old dichotomy of active vs. passive risks misleading people into believing that index funds are inert or that systematic strategies are “active stock-picking.”

By focusing instead on cost and discretion, we put the emphasis where it belongs: what investors are paying for, and what they’re actually getting. This perspective also helps investors avoid dogmatism. Mega-cap U.S. stocks may be efficient, but niches like micro-caps or specialized bond sectors like munis and mortgages still offer opportunities.

Increasingly, low-cost, systematic managers are sensibly applying some discretion within predefined risk parameters that don’t allow them to deviate too much from the indexes. In my view, that’s where the future lies—beyond the active/passive debate and squarely aligned with our investment philosophy.