Active vs Passive Management – Which One is Better?

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Published by Taylor Financial Group

Investors are faced with many choices when making investments for their future.  One of the biggest choices, and most widely debated, is whether to make investments in active or passive investment strategies. 

An actively managed strategy is one in which (as it is named) a manager is actively managing the underlying stocks, sectors, and geographic locations for a portfolio.  A passively managed strategy is one that invests in broad markets, generally through the use of low cost Exchange Traded Funds (ETF’s) that are designed to track broad market indices such as the Standard and Poor’s 500, Russell 2000 (small cap), and MSCI EAFE (international).

At the center of the debate is the economic principal that markets are “efficient.”  This means that the same information is widely available to everyone and is priced into market movements in real time.  Critics of active management contend that if markets are considered “efficient,” then the active managers have no edge in investing and should not be able to outperform a broad diversified basket of stocks (the index) over the long term.

Barron’s recently released an article emphasizing that the debate between active and passive management does not need to be a zero-sum game, meaning that investors can actually benefit from having both investment strategies in their portfolio.  However, the article did note that there is no perfect science to deciding the right mix of passive and active investments.  Deciding on the allocation within the portfolio takes careful consideration of the client’s situation as well as the ability to find effective managers.  Indeed, according to Vanguard, “The right amount of active comes down to three things: the ability to pick above-average managers, cost, and investors’ risk tolerance, or patience in holding active managers through their ups and downs.”

In addition, the Barron’s article reviewed the potential benefits of having both active and passive management strategies.  One of the major benefits highlighted is lowering the overall risk of the portfolio.  According to the article, active and passive management strategies tend to outperform at different points in the market cycle.  In the early and middle stages of the market cycle, passive strategies tend to outperform while active strategies do better in the later stages of a bull market.  Having both in a portfolio can help reduce volatility by having strategies that perform well at different points of the market cycle.

At Taylor Financial Group, we firmly believe that there is no one right solution for any client and that what is right for one client, may not be right for another.  We advocate that there is value in both active and passive strategies and that a well-diversified portfolio should include both.  Rather than helping clients decide whether to invest in active or passive strategies, we feel it best to help investors to find the right balance between active and passive investment strategies for their specific needs and risk tolerance.

If you would like to review your portfolio and discuss how we can help you pursue your goals, give us a call today.  We are always here to help!

Sources:
Barron’s, Active or Passive? Why You Should Use Both, July 29, 2017
Vanguard, Making the Implicit Explicit: A Framework for the Active-Passive Decision, May, 2017
 
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine what is appropriate for you, consult a qualified professional.
 
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
 
The Russell 2000 is an index measuring the performance approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. The Russell 2000 serves as a benchmark for small-cap stocks in the United States.
 
The MSCI EAFE index represents the performance of large- and mid-capitalization companies in the EAFE (Europe, Australasia, Far East) region. The MSCI EAFE index covers approximately 85% of the free float-adjusted market capitalization of each of the countries included in the index.
 
Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.
 
Exchange-traded funds are sold only by prospectus. Please consider the investment objectives, risks, charges and expenses carefully before investing. The prospectus contains this and other information about the investment company, can be obtained from your financial professional at Taylor Financial Group, 795 Franklin Avenue, Bldg. C., Suite 202, Franklin Lakes, NJ 07417. Be sure to read the prospectus carefully before deciding whether to invest.” 
 
No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not ensure against market risk.
 
Securities offered through Cetera Advisor Networks LLC, Member FINRA/SIPC. Investment advisory services offered through CWM, LLC, an SEC Registered Investment Advisor. Cetera Advisor Networks LLC is under separate ownership from any other named entity.

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