Active investing, as its name implies, takes a hands-on approach and requires that someone act in the role of portfolio manager. The goal of active money management is to beat the stock market’s average returns and take full advantage of short-term price fluctuations. It involves a much deeper analysis and the expertise to know when to pivot into or out of a particular stock, bond, or any asset.
A portfolio manager usually oversees a team of analysts who look at qualitative and quantitative factors, then gaze into their crystal balls to try to determine where and when that price will change.
Active investing requires confidence that whoever is investing the portfolio will know exactly the right time to buy or sell. Successful active investment management requires being right more often than wrong.
An example of a passive approach is to buy an index fund that follows one of the major indices like the S&P 500 or Dow Jones. Whenever these indices switch up their constituents, the index funds that follow them automatically switch up their holdings by selling the stock that’s leaving and buying the stock that’s becoming part of the index.
This is why it’s such a big deal when a company becomes big enough to be included in one of the major indices: It guarantees that the stock will become a core holding in thousands of major funds.
When you own tiny pieces of thousands of stocks, you earn your returns simply by participating in the upward trajectory of corporate profits over time via the overall stock market. Successful passive investors keep their eye on the prize and ignore short-term setbacks—even sharp downturns.
• Flexibility: Active managers aren't required to follow a specific index. They can buy those "diamond in the rough" stocks they believe they've found.
• Hedging: Active managers can also hedge their bets using various techniques wheres Passive managers are stuck with the stocks the index they track holds.
• Tax management: Even though this strategy could trigger a capital gains tax, advisors can tailor tax management strategies to individual investors, such as by selling investments that are losing money to offset the taxes on the big winners.
• Active risk: Active managers are free to buy any investment they think would bring high returns, which is great when the analysts are right but terrible when they're wrong.
• Ultra-low fees: There's nobody picking stocks, so oversight is much less expensive. Passive funds simply follow the index they use as their benchmark.
• Tax efficiency: Doesn't typically result in capital gains tax for the year.
• Too limited: Passive funds are limited to a specific index or predetermined set of investments with little to no variance; thus, investors are locked into those holdings, no matter what happens in the market.
• Small returns: By definition, passive funds will pretty much never beat the market, even during times of turmoil, as their core holdings are locked in to track the market.
We believe that combining the two can further diversify a portfolio and actually help manage overall risk.
Starting with a core allocation to an index, to be determined based on a client by client basis, there will be a certain allocation of funds to be used for the active investing side. This is where we will be looking for those diamonds to out-perform the index and also used for hedging the overall portfolio when it gets into historically overbought areas.
Those looking for a greater reward to risk scenario to out perfom the index can increase the allocation to the active side, while those looking for less volatility will lean to the more passive side. But either way, still has the availiblity of hedging the risk to their overall portfolio, which is something not afforded by straight passive investing.