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Active vs. Passive Investing

Active vs. Passive Investing

February 12, 2018
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Today I want to talk to you about some of the differences between Active and Passive investing and what that means to you. Today we are going to talk about this at a very high level, because I don’t want to get to deep in the weeds with investing, but I do want to talk about the differences how that can affect you from a Fee standpoint.

My purpose today isn’t to try and sway you to one mindset versus another. My goal today is to simply explain some of the different nuances and explain a bit about the philosophy we employ at Redstone Financial Group.

Let’s first discuss the differences between Active vs. Passive, then we will get into some of the pros and cons of each philosophy.

Passive Investing

Typically, the someone that is interested in a Passive investment approach has a long-time horizon for their money. When someone employs a Passive investment philosophy, they are interested in a buy-and-hold type thought process. Because they are limiting the amount of trading in their account, they are not reacting emotionally or trying to time the stock markets next moves. The Passive investor feels that the markets are efficient, and no amount of research or timing will yield them a better rate of return than just letting their investments sit and grow in the original allocation they chose when they opened the account.

A great example of this would be investing in an index fund or even an ETF (exchange traded fund) that mirrors a major index, like the S&P 500 or the Dow Jones. Because an ETF or an Index fund is simply mirroring a major index, they are employing what we call a “Me Too” mentality. For example, if you are investing in a S&P 500 Index Fund, that will fund will simply look at what the S&P 500 is invested in and say, “Me Too” and that is what the fund will invest in. If the S&P 500 makes a change, so does the Index Fund. This is why Passive investing tends to be less from a fee standpoint. Since the fund is simply following an index, you will avoid many of the transaction costs associated with a lot of buying and selling of different stocks.

The pros of Passive Investing are the following:

  1. Typically, they have lower internal expenses
  2. Because passive investing uses more of a buy-and-hold type strategy and there is not as much active trading, Passive investing tends to be more tax efficient, thus avoiding some on-going capital gains taxes.

Active Investing

With Active investing, there is a more direct approach to the investment philosophy. When someone is actively investing, there is a portfolio manager who oversees the building and managing of the portfolio. This manager’s job is to look for areas of the markets where there are opportunities for growth and take advantage of those areas. They are trying to beat the stock market’s returns. These portfolio managers are doing a lot of research to find areas of the market where they can eek out a bit more return than the indexes. These portfolio managers spend their time looking at all the qualitative and quantitative data that is available for all the individual stocks and mutual funds in the portfolio.

The pros of Active investing are the follows:

  1. Active money managers tend to have a bit more flexibility in their ability to buy the investments that they want. Because the portfolio managers are doing such extensive research, they may come across an investment that they want in their portfolio. If the portfolio was Passive in nature, they may not be able to buy the stocks they want, because the portfolio must follow an index.
  2. A second pro of Active investing is the ability to take a more hands on approach to tax management. An active manager can employ a strategy called tax-loss harvesting to help manage taxes inside of a portfolio. This concept is basically the act of selling off the stock positions that are down to help offset other realized gains in a portfolio.

The point of this explanation is not to tell you to stay away from one concept and always go with another, but simply to help educate you to the difference so you know what questions to ask in regard to your investments.

At Redstone Financial Group, we apply a mix of Active and Passive investing for our clients, depending where each makes sense. When strive to keep the underlying positions in every account as inexpensive as possible, while also employing strategies that help manage investment, tax and economic conditions.

If you would like some help with your investment portfolios, we can schedule a phone call to discuss a game plan that is right for you. You can do so by clicking on the “Schedule Now” button below and grabbing your slot on our calendar, and thanks for watching.