Investing: Active Vs. Passive Styles

By Jon L. Ten Haagen, CFP ®

Depending on who you listen to and the time period, one or the other style of investing, active and passive, will be winning. Let’s take a look at both.

Passive Investing: An investor buys a basket of stocks (or bonds or alternatives) and normally adds to their investment on a regular basis (think about how your 401k, 403b or 457 plan works at work). This is called Dollar Cost Investing. They do this consistent buying whether the stock market is up or down.

Active Investing: Investors research and follow companies closely and buy or sell stocks based on their view of the future. The companies services, products, supply and demand.

Which style works for you? Passive investing seems to have the edge lately. About 83-95 percent of active money managers fail to beat their benchmark returns in any specific year. Many investors want to join the winning team and are going on the passive side.

Passive investors are buying stocks and bonds mechanically meaning they are accepting the investments within the index they want to follow. This style uses computer and software to move money around rather than a high-priced professional. They can get a lower expense ratio, keeping annual cost lower. Costs factor into the total return.

There are many indexes to choose from. There is the Dow Jones, S&P500, NASDAQ, international indexes and specific indexes like the large cap stocks, med-cap, small-cap, and by industry, geography, country, socially responsible companies, green companies and many other niche arenas.

To get the market’s long-term returns you have to buy and hold for the long term. This is difficult because we watch and listen to the TV and radio and listen to the commentators constantly stirring the pot of worry.

Active investors are tempted to sell investments when they go down. Buy positions when their value goes up. Stop buying after the market goes up or down. All these moves will reduce your returns. Each move generates commissions and or fees. Between 83- 85 percent of active professional managers fail to beat their indexes in any given year. Therefore, buying and holding an active manager is not necessarily the answer.

Consider the case of Peter Lynch, one of the top stock pickers in the world. Lynch ran the Fidelity Magellan fund for 13 years. He made an impressive average return of 29 percent per year, almost double the market’s return in the same time period. Even the best known managers like Warren Buffett and Sir John Templeton faltered at times. Many of the investors who followed Lynch actively traded his fund trying to do better. The more astute ones did about a 7-percent average, and some of the average investors were lucky to break even. Passive investors who followed Lynch did  well because they bought and held on.

You have to take some time to seriously consider what it is you want to accomplish and are comfortable with. Do you want to play the market and see if you can beat it? Do you have the time, desire, and expertise to take the time for this activity? Or do you want to find a good counselor/planner to help you make decisions and stay the long-term course of getting you to a comfortable retirement? It is a long term commitment on your part. I have never had anyone come into my office and ask me to explain the VIX, or tell them how the NASDA works. No, they want to know how to pay off the mortgage, get the kids thru college, put enough away to enjoy retirement and play with the grandkids and take a few fun trips.

As always, we are here to answer your questions and help you to choose the right path. Call or email us for help.