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July 1, 2019 • 7 minutes
When it comes to managing investments, there are two main philosophies: active investing and passive investing.
Active management is a hands-on investing approach consisting of investors who are looking to beat a specific market index (or benchmark) through targeted investing, timing the market, and any number of strategies that seek higher than average returns.
As an active investor, you may have a lot of individual common stocks or actively managed mutual funds or active Exchange-Traded Funds (although to a lesser extent) within your investment portfolio. Actively managed funds are funds with portfolio managers that select investments that seek to outperform a benchmark. You may also utilize more alternative investments, like private equity and hedge funds.
Through active management, investors have a strong belief that skillful portfolio managers can outperform the market by leveraging price movements, market conditions and events.
While an active management approach is looking to outperform a specific segment of the market, a passive management philosophy consists of investors who are just trying to capture the returns of the market while keeping investment costs low. The investment portfolio of a passive investor may consist of index funds and/or passively managed ETFs.
A passive investor isn’t concerned as much about capitalizing on short-term market movements or particular market events (i.e. market timing) and instead believes in the long-term potential of an investment over an extended period (i.e. a buy and hold strategy).
A passive investment strategy operates under the assumption that market efficiency over the long term will produce optimal results.
As the names imply, an active investor is attempting to beat the stock market whereas a passive investor believes As the names imply, an active investor is attempting to beat the stock market whereas a passive investor believes markets are efficient and is trying to capture the returns of a specific sector of the market. Passive funds don’t have human managers making decisions in order to try to beat the stock market. With no managers to pay, passive funds generally have very low expense ratios. Although fees for actively managed funds have decreased over time, index funds and passive ETFs are still the winners here according to the Investment Company Institute 2023 Investment Company Factbook.
Most of the professional fund managers who engage in active trading of stocks or bonds are often unsuccessful at generating returns that are better than the index they are trying to beat.
While active managers can indeed outperform the market from time to time, these periods of higher returns are often brief.
Passive investing, with its set-it-and-forget-it approach, offers a profound reduction in stress and an increase in financial confidence for investors. Once you’ve selected a few index funds or ETFs and are comfortable with your asset allocation, most of the hard work is done. With a long-term perspective, minimal intervention and oversight is needed going forward.
Rather than being consumed by the anxiety of timing the market or reacting to short-term volatility, passive investors can focus on their long-term financial goals with a clear mind.
By embracing that markets are efficient, you recognize that a long-term, globally diversified, and low-cost passive portfolio offers a more relaxed and zen approach to investing.
Actively managed mutual funds often come with a high turnover rate due to frequent portfolio management decisions. A turnover rate is the percentage of a fund’s holdings that have been replaced in the previous year, leading to taxable capital gains. For instance, a fund with a 100% turnover rate would essentially have an average holding period of less than one year.
Meanwhile, a passive investment strategy of index mutual funds and ETFs with built-in tax efficiency can minimize the tax drag on your returns. These funds are often more tax-efficient than active funds because they typically have lower turnover rates. An index fund’s buy-and-hold style leads to fewer taxable events and often minimal, if any, capital gains distributions. ETFs may offer an additional tax advantage: The ETF redemption process sometimes allows ETF managers to adjust for market changes without directly selling portfolio securities (saving on capital gains taxes).As an investor, you should strive to reduce these tax costs and performance drags wherever you can. Utilize the Boldin Retirement Planner to review your potential federal and state tax burden in all future years and get ideas for minimizing this expense.
Investing can be as simple or as complicated as you want it to be. It can save you time or it can take away a lot of your time, depending on your investment strategy.
There can be significant time and effort put into your actively managed portfolio with many questions to ponder such as:
Meanwhile, with passive investing, you can essentially pick 1 to 3 index funds or ETFs and set it and forget it. One of the few key decisions you have to make as a passive investor is determining the right mix of stocks and bonds (e.g. 60% stocks and 40% bonds) to align with your financial goals and risk tolerance. It’s a lot less time-consuming than the buy-sell, market timing questions and decisions that often come with investing in actively managed mutual funds, private equity, and hedge funds. NOTE: Spend less time managing your investments by adopting a passive investment philosophy and focus more on planning your future retirement with the Boldin Retirement Planner.
Since passive strategies often focus on index funds or ETFs, you’re usually investing in hundreds, if not thousands, of stocks and bonds. This allows for easy diversification and reduces the risk that a single investment performing very poorly will significantly impact your entire investment portfolio.
On the other hand, if you’re handling active investing on your own without proper diversification, a few poor stick picks or actively managed funds could erase significant gains in your investment portfolio. Building a globally diversified portfolio through active management can be both time-consuming and expensive, requiring a lot of effort and potentially high fees.
Utilize the Boldin Retirement Planner to build, track, and manage all aspects of your comprehensive financial picture: investments, recurring expenses, medical costs, long-term care, real estate and more. The tool can play a vital role in helping you make informed decisions about your strategies and their impact on your financial security now and in the future.
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