Actively Passive or Passively Active?

Actively Passive or Passively Active?

Robert Lindstrom

There seems to be a lot of talk in the news these days about active investing and passive investing. It appears that a lot of people don’t really know the whole story. When people use the terms active investing and passive investing, they are usually talking about exchange-traded funds (ETFs) or index funds that track a specific area of the market. For example, an S&P 500 index fund typically owns a tiny bit of each company in the S&P 500, and their performance closely mirrors that index, less some management fees, and therefore they should never do better than their index. These “passive” investments usually have low fees because there isn’t a management team trying to beat the market. Active funds are usually more expensive, but you invest in them in the hopes that they can outperform their benchmark after the higher fees.

To illustrate how this would work in a real-life example, let’s look at Amazon.com and Pepsi. An index fund might own both of these companies, regardless of their respective financial prospects, just because they are in the index. An active fund could have tried to determine which investment would increase more in value over time and buy only that one.

So what does all of this mean to you the investor? I would argue that whether you prefer to invest actively or passively will not matter as much as many people think. The market is not something we can control, so we focus on the things we can, starting with the right allocation of stocks to bonds according to your risk tolerance and capacity to handle the ups and downs of the stock market. A good allocation will also consider different kinds of assets and which accounts you should own them in. It is also important to get the non-investment aspects right, too, that is, having the right types and amounts of insurance, paying as little in taxes as possible while correctly preparing your returns, getting the most out of your company or government benefits, and being smart about debt. The active or passive debate loses some of its importance in the light of a well-designed and comprehensive financial plan.

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