By Gary Meeks, RICP®
Let’s talk money management, let’s talk mutual funds and ETFs (Exchange Traded Funds). Generally, there are two types of management, active management and passive management. What is the difference, and which is better? I’ll discuss the differences, some advantages and disadvantages of each, but which is better has been debated for years. I think the answer may be that both have their place in an investment portfolio.
Active Management:
Every mutual fund or ETF has a stated investment objective. Actively managed mutual funds or ETF’s are assigned one or more fund managers. After conducting research and analysis, the managers select what they feel are the best securities to meet the funds objective. Often, one goal of the fund manager/managers is to beat the performance of a benchmark index such as the S&P 500 index or to provide similar returns with less risk.
Passive Management:
With passive management, the managers or creators of the fund do not conduct analysis, research or pick securities that they feel will outperform; rather, the fund seeks to own the same securities that exist in a certain index such as the S&P 500. There are many indexes, including indexes for international securities, smaller companies, fixed income securities, technology stocks, real estate and so on.
Weighing the Potential Benefits of Each:
Active management tends to cost more because fund managers are getting paid to analyze and pick securities as well as additional cost associated with more frequent trading. So, all else being equal, the lower cost of passive management is an advantage. The question then becomes “Can the active manager outperform his or her benchmark after expenses?” There are funds/ETFs that have outperformed their benchmarks after fees, but this has proven very difficult.
There may be other things to consider like risk-adjusted returns. Morgan Stanley’s Dan Hunt, Senior Investment Strategist, noted, “Morgan Stanley Wealth Management has found that in many cases, active management may help investors improve their risk-adjusted returns. We’ve found that active managers can be especially helpful during periods of market stress when outperformance can be most critical for investors. Active strategies have tended to benefit investors more in certain investing climates, and passive strategies have tended to outperform in others. Generally, when the market is volatile, active managers may outperform more often than when it is not. When specific securities within the market are highly correlated or moving in unison, passive strategies may be the better way to go. “ https://www.morganstanley.com/access/active-vs-passive-investing
Why Not Consider Both?:
In my practice at Meeks Financial, I employ both strategies in creating model portfolios for clients. Often, I will use an index fund or ETF that tracks the S&P 500 to give my clients broad exposure to large cap US stocks at a low cost while using active funds in other areas such as small cap stocks or international securities or other areas where I feel active management may add value.
There are many things to consider when making investment decisions and the above topic is just one. Other important factors include personal priorities, investment timelines and goals.
Gary D. Meeks, RICP®, is a registered representative offering securities and advisory services through Cetera Advisor Networks LLC, member FINRA/SIPC, a broker dealer and Registered Investment Adviser. Cetera is under separate ownership from any other named entity. 90 W 100 N STE 6, Price, UT 84501 (435) 637-8160.
The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. Investors can not invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing. “The Standard & Poor’s 500 is an unmanaged group of securities considered to be representative of the stock market in general. Past performance does not guarantee future results.”
Mutual Funds and Exchange-traded funds are sold only by prospectus. Please consider the investment objectives, risks, charges and expenses carefully before investing. “The prospectus contains this and other information about the investment company, can be obtained from your financial professional at 435-637-8160. Be sure to read the prospectus carefully before deciding whether to invest.
Important Information:
Index Definitions
S&P 500 Index: The Standard & Poor’s (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.