Savings & Investing Active vs. Passive | Active vs. Passive |
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If you ever want to start a fight, get a bunch of finance people together and have them debate which is better active or passive investing. Believe me the passion displayed by both sides almost rivals that of participants in the East coast vs. West coast rap beef of the 90’s. We are not going to decide for you which strategy is better, but we will give you information you need to make a decision. After all it is YOUR money. Active Investing is the strategy of ongoing buying and selling by the investor. Active investors purchase investments and continuously monitor their activity to exploit market inefficiencies. Essentially, managers of active mutual funds are trying everyday to beat the benchmark (sit tight and I will explain in a few what the benchmark is). There are many methods to accomplish this, too many to explain here, but most include analyzing individual securities and making a hypothesis about its future direction. If the Portfolio manager feels the security is going to increase in value he/she will buy it, if he/she feels the security will decrease in value they will either sell it if it is already in the Portfolio or not buy it at all if it is up for recommendation. Stock picking is NOT an easy thing to do. Believe me I have tried and failed, however most fund managers are super bright people with years of experience and a crew of analysts helping them out, so they tend to make rational decisions(hopefully), something the average Joe investor has a problem doing. When you invest your money in an actively managed fund you are betting that the Portfolio manager will deliver above average returns to you. Unfortunately, research has shown that between the years of 1984-2004 the average stock investor had returns of 3.7 %/yr while the S&P 500 returned 13.2%. So if you are in an active fund make sure it’s a good one. Passive Investing is a strategy where the Portfolio manager makes as few Portfolio decisions as possible. It’s the old buy and hold…and hold… and hold model. This is primarily done by the use of index funds. An index fund is a collection of securities whose aim is to replicate the movement of a specific index. Common indexes are the S&P 500, the Russell 2000 and the MSCI EAFE. These indexes are usually the benchmarks that the above mentioned Portfolio managers are trying to beat. Because there are few transaction costs, index funds are a lot less expensive than active funds which greatly assist in return figures. Indexing takes the human element out of Portfolio management, letting the Portfolio run on autopilot. Essentially, your Portfolio will return what the market returns, no better and no worse. Once again, we are not here to tell you what to do, but before you invest be sure to research the mutual fund. If it is an actively managed fund, be sure to learn about the manager’s history and process, you can even call the company to get more information. Also, try to keep the costs as low as possible, be wary of higher than average expense ratios and sales charges.
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