The debate between active and passive investing strategies often confuses many investors. While ‘passive’ implies a hands-off approach, the reality is more complex. For example, our automated investing platform utilizes both strategies but leans towards passive. However, daily trading activities in our portfolios often contradict this notion of passivity.
Each year, we reassess asset allocations in our portfolios to align with current global market conditions and long-term projections. This ongoing adjustment underscores the active engagement inherent in what is classified as passive investing.
Defining active and passive investing
Understanding the differences between these strategies requires examining their core objectives and associated costs. Both approaches involve investment decisions, whether made by a retail investor or a team of professionals. However, the primary distinction lies in their objectives.
Challenges of beating the market
Achieving superior market returns is complex, especially over extended time frames. The S&P 500, often regarded as the benchmark for U.S. large-cap stocks, illustrates this challenge. Research indicates that fewer than 15% of actively-managed funds consistently outperform this index over five years or more. This statistic prompts a critical inquiry: is active investing truly worthwhile?
Despite these challenges, active investing can prove advantageous in certain scenarios. Less efficient markets than the S&P 500 present opportunities for informed investors to identify hidden value. Emerging markets and specific bond markets often require deeper insights and access to detailed information, creating potential advantages for savvy investors.
Evaluating active management
Investing in an actively-managed fund entails not only investing in underlying assets but also in the expertise of the management team. It is essential to conduct thorough research on their performance history and strategies prior to committing funds. Our firm employs both quantitative and qualitative analyses to assess the management teams behind the ETFs included in our portfolios.
Exploring niche markets
Moreover, unique investment opportunities may lack passive index equivalents. A notable example is the Academy Veteran Bond ETF (VETZ), an actively-managed fund focusing on loans to current and former U.S. military personnel and their families, appealing to those interested in socially responsible investing.
Additionally, many investors derive satisfaction from selecting their own investments. A survey conducted among Betterment customers revealed that approximately three-quarters mix self-directed investments with managed portfolios, blending personal choice with professional guidance.
Active versus passive: a balanced approach
In investment strategy, choosing between active and passive does not need to be an either/or decision. At Betterment, we embrace both methodologies and often utilize a hybrid approach to optimize wealth-building. Each strategy offers unique benefits and can play various roles in a well-rounded investment portfolio.
For instance, stock indexes are constructed based on the market values of constituent companies, which fluctuate over time. This dynamic nature ensures that underperforming stocks gradually lose their index weight while successful companies gain prominence. Consequently, the composition of the S&P 500 today differs significantly from its form two decades ago.
Each year, we reassess asset allocations in our portfolios to align with current global market conditions and long-term projections. This ongoing adjustment underscores the active engagement inherent in what is classified as passive investing.0
Each year, we reassess asset allocations in our portfolios to align with current global market conditions and long-term projections. This ongoing adjustment underscores the active engagement inherent in what is classified as passive investing.1