An introduction to the age-old “Passive versus Active Asset Management” debate. What is passive investing? What is active investment management? How do they differ? What are the keys to success when implementing a passive or active investing strategy?
All that and more in Episode 35 on the Wilson Wealth Management YouTube channel.
“What is passive investing? What are the keys to success in passive management?”
Passive investors do not attempt to “beat the benchmark”. They simply invest in the entire market.
That may be a broad market, such as the S&P 500. It may be an asset subclass. Australian mining companies. High-Yield corporate bonds. Regardless of the chosen benchmark index, passive investors just invest in the market.
Passive investors do not actively trade. They invest in the market and try to match the benchmark return as closely as is possible. Passive investors also work to minimize their investment costs.
Identify the asset class and subclass to invest in. Match the market return. Minimize investment costs.
“What is active investing? What are the keys to success?”
Pretty much the exact opposite.
Active asset managers believe they can outperform their benchmarks. That they can achieve “alpha”.
As with passive investing, the benchmark can relate to broad or narrow asset classes and subclasses.
There may, or may not be, extensive trading. Active refers more to the ability to trade and select specific investments. Not the requirement for constant buying and selling of assets.
Cost consciousness is probably nice. But active managers are primarily concerned with outperformance of their portfolio’s net returns. If it costs 2.5% per annum to actively manage an investment fund, the only issue is if the managers can generate 2.51% in excess performance.
Within the designated benchmark index, identify the “best” investments. Invest, then adjust over time as market conditions shift and/or “better” investments come along. As long as the active manager can generate “alpha”, costs are not a major concern.
Find the “best” investments. Outperform the market return. Costs, meh.
“Why the “debate”?”
On the surface, it seems obvious that active asset management should easily outperform a passive approach.
For example, perhaps my benchmark is the S&P 500. This consists of (approximately) 500 US large cap equities.
As a passive investor, I simply buy all 500 companies in their index allocation. Usually via an index mutual, or exchange traded, fund.
As an active investor, I use my professional skills and experience to analyze all 500 companies. I discard the worst 200. Ignore, or underweight, the middle tier stocks. And load up on the 25-100 companies that I consider to be superior investments. As conditions change, so too does my portfolio.
The passive investor is saddled with all 500 companies. The good and the bad. The active manager only invests in the “best” stocks.
So why is there any debate?
A professional investor who can pick and choose will outperform a passive investor all the time.
Right?
For a little more detail on this topic, please refer to “Passive versus Active Investing”.
