“On the eleventh day of Christmas my broker gave to me…11 active managers…”

In the investing world there are two different viewpoints, active management verses passive management. The active manager creates a strategy where their goal is to outperform a specific benchmark or what we call an index.

An index is basically all stocks or bonds in a particular area; for example, the S&P 500 is regarded as the largest 500 companies in the US.

The active manager can use any means necessary to accomplish their goal, as specified in the prospectus of the fund or their investment policy statement. Their desire is to exploit market inefficiencies by purchasing stock that is “undervalued” or short selling stock that is “overvalued.” Different companies use different valuation techniques to determine whether or not a stock is under- or overvalued. Needless to say the reason why they are called ACTIVE is due to the fact they are constantly buying and selling securities because of their predictions. Also, since there is that continuous trading going on, there are more fees inside the fund.

If you are purchasing a mutual fund for the purpose of holding it for a long period of time and you want to know what you hold and why, then having an active manager might not be the best choice for you. On the other hand if you want someone who is buying and selling stock due to their belief that they can predict when a company’s stock price might go up or down, then active investing is for you!

For those people who have a desire to know what they hold, know why they hold it, and have a better expectation of how their portfolio will react in good and bad periods of the markets, then perhaps passive investing is more suitable. Passive investing, otherwise known as index investing, is an investing strategy that does not entail any forecasting methods like trying to pick the right stock at the right time or jumping into cash and out of the stock market. The idea is to minimize fees and avoid the consequence of failing to correctly anticipate the future.

By tracking a specific index there is a lot less portfolio turnover, lower management fees, and a higher probability of diversification. You are able to be more specific about the ingredients in your portfolio and be assured that you know what you hold. If you want the 500 largest US companies, then you buy an S&P 500 index fund. If you want a short term government bond fund, there are those too. By holding specific securities for a long period of time you are better able to control the risk, or what we call standard deviation, in your portfolio. These are important concepts that need to be known by all investors, even if it is just an overview of how investments work. The more you know, the better decisions you can make. Don’t follow the herd, stand out in the crowd!

Know It, Own It, And Control It!

Philip A. Guske