Active vs Passive Investing – And the Winner Is?

Active vs. Passive Investing

The debate of active vs passive investing has been raging since the 1970s. Proponents on both sides offer up what they purport to be objective evidence that supposedly supports their respective positions. If you are not that familiar with the active versus passive debate, let me briefly explain.

Active management proponents

Active managers believe that the stock market is inefficient and that anomalies and irregularities exist in the capital markets which can be exploited on a cost adjusted basis by those with skill and insight for profit. They believe that stock prices react to information slowly enough to allow a savvy investor to outperform the market. Active management is the predominant form of investing in today’s market.

Passive management proponents

Passive investors believe that the stock market is efficient and therefore stock prices are always fair and quickly reflective of information. Proponents of passive management believe that consistently outperforming the market on a cost adjusted basis for the professional and small investor alike is highly unlikely. Therefore, passive managers do not try to beat the market, but only to match its performance by investing in low cost passive forms of investments such as index funds or ETFs (Exchange Traded Funds).

As an independent fee based advisor, I’ve been analyzing the data on the active vs passive investing debate for close to 20 years and feel that both sides make reasonable points. But in my opinion, both sides engage in the twisting of data to support their position. I manage portfolios using pass ive strategies as well as active strategies depending upon the views of the client. I charge the same for active investments as I do for passive strategies.

At the end of the day, I do not have a definitive answer and nor does anyone else. In fact, I believe there may never be an answer to this debate. However, what I can say is that proponents of active or passive investing would probably agree that the debate is in reality a secondary concern for individual investors.

Listen to our discussion on active vs. passive investing from the Financial Spotlight radio show.

In summary, when it comes to your investment portfolio, you should be concerned with:

  • Having a solid asset allocation strategy based on your personal tolerance for risk and your goals, resources and time frames
  • Making rational, not emotional decisions with your money
  • Creating a comprehensive financial plan that works for you and your family.

These variables will play a significantly greater role in the overall return of your portfolio than an active or passive investment strategy ever will.  Keep your eye on what is important and don’t lose sleep over whether or not you should maintain an active vs. passive investment strategy – There are more important things to lose sleep over such as how you are going to pay for college or subsidize aging parents and God only knows what else.