Understand the differences of active and passive strategies and determine which better suits your goals.
When it comes to your retirement portfolio, should you try to beat the market or simply move with it? Growing wealth can happen in a myriad of ways, but one of the great debates in portfolio management is whether active or passively managed investment strategies are more fruitful. Regardless of your personal preference or market conditions, the passive-active portfolio management debate may not be an either-or decision. There are other factors to consider.
Generally, actively managed investment strategies attempt to outperform a broad market index by selecting attractive investment opportunities within a stated mandate. For example, an active manager’s mandate may be to outperform the S&P 500 by investing in 20 to 30 large US company stocks. Typically, one or more portfolio managers are responsible for selecting these investments and performance is based on whether the manager selected investments that turn out to be winners.
On the other hand, passive investment strategies try to match the performance of a broad market index. For example, the S&P 500 is an index that tracks the performance of 500 of the largest publicly traded US companies. By having a sampling of investments in the benchmark across many sectors, investors get diversification with simplicity. It’s akin to owning a piece of the overall US economy. It still fluctuates but with broad market performance.
Just like many financial decisions, determining if your retirement portfolio should be managed actively or passively, will be personal. There are advantages and limitations of each and you may leverage one strategy over the other during certain market conditions or financial circumstances.
Active investment strategies rely on expert human analysis, but this may come with a cost. They often are associated with higher fees and operating expenses because people must manage them. These additional expenses reflect the costs associated with active management, and investors should evaluate whether the approach aligns with their goals, risk tolerance and preferences. The flexibility allows the portfolio manager to adjust portfolio holdings in response to changing market conditions, although such adjustments may not prevent losses. Because active strategies may involve more frequent trading, be mindful that they can be less tax‑efficient.
Passive investment strategies typically have lower fees and operating expenses, but there is less flexibility when it comes to taking defensive measures and taking advantage of market inefficiencies. It’s generally more tax efficient because there is less trading and fewer realized capital gains. With passive strategies, risk is primarily driven by market exposure rather than active security selection.
Historically, the relative performance of active and passive strategies has varied depending on market conditions, economic cycles and other factors.
The bottom line is that you should have a conversation with your trusted advisor to determine if active and passive management strategies are available in your plan’s fund. Since each provides its own benefits in different market environments, both investment styles may have a place in your retirement portfolio. Your risk tolerance, retirement timeline and goals may dictate which strategy to use. Consider cost and tax efficiency as well if those aspects are important to your overall financial situation.
Be sure to review life events with your advisor every year as they may affect your risk tolerance. Your advisor can help you make changes that will help you achieve your retirement dreams.
Investing involves risk and you may incur a profit or loss regardless of strategy selected.
