Active or Passive Investing: How to Choose Wisely

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brian-hs-customBy Brian Sterz, CFA

Historically, there are two principle options when it comes to how to invest your hard-earned money. There is the active management method, which provides a hands-on experience with a (hopefully) trusted advisor, or the passive management method, a form of investing with a laissez faire-type attitude. Each investing technique has both pros and cons, but it’s important to evaluate your circumstances to understand which specific method is best for maximizing your investments.

When does active make sense?

Active management is best suited for those who have the information, experience and time needed to focus on an area or sector considered to be their particular expertise. Investors should use active management if they have access to specific investment strategies that have demonstrated the ability to outperform their benchmarks over a period of time. The method is well suited for investors that tactically allocate portfolios between asset classes over time, because investors’ total portfolio returns are driven more by allocations to particular asset classes than by the particular stocks within them. 

If you decide to pursue an actively managed portfolio option, it’s crucial to be aware of which investments are most applicable for a hands-on approach. Active management is best suited for markets where information and analysis can be more difficult to attain—specialists in these areas may have a better chance of exceeding their benchmarks after incorporating fees. Notable sectors, like U.S. Small Cap equity, Emerging Markets equity, fixed income and High Yield bonds, can help an active investor outperform his or her fees.

When does passive make sense?

Passive investing makes sense for people who are looking to sit on their funds. These individuals want a long-term strategy that emphasizes a return from the underlying asset allocation rather than tactical positioning in fluctuating markets, but will post appropriate returns with patience, time, and low cost. This can be both a good and bad situation—many investors appreciate the status quo and value less volatility over potential investment outperformance.

A combination of the two is the best strategy for most investors.  People that understand which sectors offer the best opportunities for outperformance can utilize both active and passive management to create efficient, diversified portfolios that maximize returns while minimizing fees.  The active versus passive decision is one that is based on a predetermined strategy and philosophy, not merely reacting to whatever may be moving the markets during a particular time.  Like most investment strategies, the ability to outperform depends on maintaining whatever course you have set with your advisor through the constantly evolving markets. 

Speaking of advisors—regardless of the management approach you take with your investments, it’s imperative to hire a financial advisor who can guide you through the investment process. Even if you have extensive investment knowledge, partnering with a financial advisor is the best way to develop your expertise, skill and focus further when managing your retirement assets. 

Choosing a financial advisory firm that is completely independent from larger financial institutions—without any perceived or legitimate conflicts of interest—is a great way to get started. Independent advisors in particular provide investors with objective financial advice and seek to invest portfolios in investments they believe will put clients in the best position to outperform fees. Furthermore, these professionals will work to manage and build clients’ portfolios with the optimal mix of active and passive underlying investments at competitive fees.

Success, as defined by outperforming a particular benchmark, depends on the skill of the active manager over time, and by working with a truly skilled active manager, you can make your life a lot easier. Active and passive investing both have their positive and negative aspects, but utilizing the proper advisor is the best way to manage your money in a tactical and efficient manner.

Miracle Mile Advisors is a leader in providing independent investment advice through active indexing to high net worth families and businesses nationwide. As one of the fastest growing independent registered investment advisors in Los Angeles, the firm is committed to developing tax-efficient portfolios that benefit from the lower cost and liquidity characteristics of Exchange Traded Funds (ETFs). To learn more about Miracle Mile Advisors, please visit www.miraclemileadvisors.com.

 

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