Broker Check

Passive vs. Active Investing: The Endless Debate

| August 14, 2020
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For many years, the differences in strategies between active and passive investing has turned into a heated debate among investors, wealth managers, and portfolio managers.  An active investment strategy entails funds run by investment managers who are trying to outperform a certain index, i.e. the S&P 500 or Russell 2000, over a period. A passive investment strategy, on the other hand, includes funds that intend to match the performance of an index.  Both strategies have their advantages and disadvantages. Below is a brief description of each strategy, along with pros and cons to each.  

   

Passive investingis a strategy intended to match, not beat, the performance of a specific index or benchmark. Generally, passive investment strategies are automated with some human oversight. Fees and expenses of passive investing are typically much lower than those of active investing. Passive investors “time” the market less and are invested for the long haul. Passive investing, otherwise known as the buy-hold strategy, is typically much more cost-effective than active investing. Passive investors, however, must resist the urge and temptation to react or anticipate an asset’s next move. The most successful passive investors stay focused on their final goals and ignore any short-term or sharp market downturns.   

 

PROS:  

  1. Significantly Lower Fees: Since there is little stock picking, little oversight is needed to manage your portfolio. Passive investing typically follows an index as their benchmark and additional costs are minimized when an investor isn’t constantly buying and selling in the portfolio.  
  2. Tax Efficiency: The buy-and-hold strategy typically results in less investment-related tax consequences as a result of less trading activity in the portfolio.
  3. Lower Tracking Errors: With this hands-off approach, limiting short-term buying and selling and allowing for portfolio diversification and low-cost trading limits your investment risk.  

 

Cons:  

  1. Limited Selection: Passive investors typically follow specific indices, which have little to no variance. Passive investors typically are locked into their holdings, regardless of what occurs in the markets. 
  2. Returns Relative to the Benchmark: Passive investing, by definition, will rarely beat the market, even in times of market uncertainty and volatility as their investments are intended to follow the market.  

  

Passive investment strategies have become more and more prevalent among many investors, portfolio managers, and investment strategists over the past ten years. Below is a graph showing the cyclical nature of both passive and active performance trends.  

Active investing is a strategy intended to outperform a specific index or benchmark and is managed by human portfolio managers and analysts. The main goal of active investing is to “beat” the stock market and reap the rewards of short-term price fluctuations. Active portfolio managers must use deeper analysis and expertise of stocks, bonds, and other assets to accurately pivot in and out of said asset. Successful investors are typically “right” more often than “wrong” when buying and selling a particular asset. Although active investments may sometimes provide greater returns, both risks, fees, and expenses associated with active management may also increase, which could hamper overall performance and returns.   

 

PROS:  

  1. Flexibility in Assets: Active investment strategies allow for the investor or portfolio manager to individually research an asset and buy and sell with relative ease. 
  2. Hedging: Because of the ability to quickly move in and out of positions, active managers can hedge their bets using various techniques, such as short sales or put options.  
  3. Tax Management: Although active investing may lead to capital gains tax, active managers can tailor tax management strategies to individual investors, utilizing strategies such as tax-loss harvesting.  

 

CONS:  

  1. Expensive: Higher fees are typically associated with active investment managers as a result of increased trading activity. These fees may also eat away at any potential investment returns.  
  2. Higher Risk Strategy: Because active investment managers typically buy and sell based on their own analysis and market timing, wrong predictions may potentially lead to greater losses.  

 

Utilizing both active and passive investment strategies for diversification purposes may offer good portfolio solutions along with the ability to meet each client’s unique risk and return objectives. Long-term investing, and those who don’t give in to the temptation of short-term market fluctuations and investing opportunities due to extreme volatility, may reap greater rewards over the course of an investor’s lifetime. Historically, long-term investors are more likely to have a higher rate of success than short-term investors. 

  

Private Capital Group would like to thank you for your continued trust, and we look forward to seeing and hearing from you all very soon!  

 

Please stay safe and healthy in these difficult times.  All our best to you, your family and loved ones. 

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Private Capital Group, LLC (“PCG”), or any non-investment related content, made reference to directly or indirectly in this communication will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Information contained in this communication is based on data gathered from what we believe are reliable sources. It is not guaranteed by PCG as to accuracy, does not purport to be complete, and is not intended to be used as a primary basis for investment decisions. Further, you should not assume that any discussion or information contained in this communication serves as the receipt of, or as a substitute for, personalized investment advice from PCG. To the extent discussed herein, investment indices are unmanaged and cannot be purchased directly. Historical performance results for investment indexes and/or categories are included for informational purposes only and generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the US stock market. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. PCG is neither a law firm nor a certified public accounting firm and no portion of the communication should be construed as legal or accounting advice. A copy of the PCG’s current written disclosure Brochure discussing our advisory services and fees is available upon request.
Please Note: If you are a PCG client, please remember to contact PCG, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. PCG shall continue to rely on the accuracy of information that you have provided.
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