Investing can often feel like navigating a maze filled with jargon and conflicting advice. One of the most debated topics in this realm is the choice between active and passive investing. While the term ‘passive’ may suggest a laid-back approach, the reality is much more dynamic. For instance, our automated investment service incorporates elements from both strategies, leaning towards passive yet remaining highly responsive to market conditions.
On a typical trading day, our system is far from idle.
We continually adjust the asset allocations in our portfolios, ensuring they reflect current global trends and long-term forecasts. This raises the question: what truly distinguishes passive investing from its more hands-on counterpart, and when should each be utilized?
Table of Contents:
The fundamental differences between active and passive investing
At the heart of both investing styles lies a decision-making process—whether that be by individual investors or professional fund managers. The primary contrast between them revolves around their objectives and associated expenses. Active investing aims to outperform market benchmarks, while passive investing seeks to mirror market performance.
Challenges of active investing
Striving to beat the market can be a daunting task, particularly over extended periods. Take the S&P 500, a benchmark for large-cap U.S. stocks, as an example. Research indicates that fewer than 15% of actively managed funds have successfully outperformed this index over five-year intervals. Nevertheless, active investing does have its merits, especially for investors willing to assume more risk.
Some markets are less efficient than the S&P 500 and may offer opportunities for savvy investors to uncover hidden value. With the right expertise and access to timely information, active managers can potentially find lucrative investments in smaller or developing markets, as well as in bond markets.
The role of expertise in active investment
When choosing an actively managed fund, it’s essential to consider the team behind the investment. Their experience and track record play a crucial role in the success of the fund. Therefore, conducting thorough research on the management team is vital. At our firm, we employ both quantitative and qualitative analyses to evaluate the teams behind the ETFs we include in our portfolios.
Niche markets and investment options
Moreover, in certain niche markets, passive index funds may not even be available. A prime example is the newly introduced Academy Veteran Bond ETF (VETZ). This fund focuses on loans to active and retired U.S. service members, making it a perfect fit for those interested in socially responsible investing while still engaging in active management.
Interestingly, many retail investors enjoy taking an active role in their investment decisions. In a survey conducted with Betterment clients, three-quarters expressed a preference for incorporating some degree of self-directed investing alongside professionally managed portfolios. This hands-on approach can be both thrilling and informative.
Understanding investment choices: active vs passive
Investors can often discern the active versus passive split within their portfolios based on the level of detail they pursue. Stock indexes, such as the S&P 500, are weighted according to the market capitalizations of their constituent companies. As these values change, the composition of the indexes and the funds tracking them also evolve. This natural self-regulation allows the indexes to shed lower-performing stocks over time, leading to a vastly different makeup compared to decades ago.
Furthermore, there’s an emerging investment strategy known as smart beta. This hybrid approach combines elements from both passive and active investing. Fund managers start with a defined index and then modify it based on quantitative factors, enhancing the potential for returns. One such product we offer is the Goldman Sachs Smart Beta portfolio, which prioritizes investments in companies meeting specific performance criteria.
On a typical trading day, our system is far from idle. We continually adjust the asset allocations in our portfolios, ensuring they reflect current global trends and long-term forecasts. This raises the question: what truly distinguishes passive investing from its more hands-on counterpart, and when should each be utilized?0
