When it comes to investing in public markets, one of the most debated topics is the choice between active and passive investing. In recent years, we’ve seen the rise of passive investing with the advent of exchange-traded funds (ETFs) and their consistent outperformance compared to many active peers. By contrast, active management has exhibited persistent outflows, leading some to question its prospects.
As we look at history, it’s important to remember that the preference for active or passive investing has been cyclical. There have been stretches when passive strategies have delivered superior performance and others when active management has proven its value. The last decade has been a favorable period for passive, with seven of the last ten years delivering double-digit returns in US equity markets.
Let’s explore the advantages and drawbacks of active and passive investing so you can consider how you might incorporate both into your portfolio.
Understanding the Differences
Active Investing
Active investment strategies generally involve selecting individual securities with the goal of outperforming a benchmark index. Proponents of this approach highlight its ability to exploit market inefficiencies as market prices deviate from their intrinsic values.
Key advantages of active investing include the potential for enhanced returns and greater downside protection during volatile markets. However, it also comes with potential underperformance, higher costs, and tax inefficiency.
Passive Investing
Passive investing aims to replicate the performance of a specific market index by investing in the same securities in proportion to their index weights. The goal is to match the index performance, not beat it.
Advocates argue that markets are generally efficient, making it difficult for active strategies to outperform after accounting for fees. Limitations of passive investing include potential concentration risks, average returns, and weaker downside protection in turbulent markets.
New to investing and need some guidance on the basics? Check out our article on stock investing for novices.
Investor Implications
The cyclicality of active and passive management underscores the importance of maintaining perspective and avoiding the pitfalls of chasing returns. Passive investing often thrives in broad bull markets (i.e., periods when rising tides lift all boats), while active management can add value in periods of market turbulence and heightened return dispersion.
Following a decade of strong, broad-based performance, the investment landscape will likely present new challenges. Active management can be critical to achieving long-term investment objectives in this environment.
Building a Balanced Portfolio
At Carlson Investments, we recognize the value of both approaches and offer a range of solutions tailored to our clients’ needs. Our offerings include active equity and credit strategies and model portfolios that integrate both active and passive investments.
Wondering where to start? We’re here to help you navigate these choices! Don’t hesitate to contact us with any questions or to learn how our solutions can support your investment goals.
Carlson Investments does not provide tax, legal, or accounting advice. This content has been written for informational purposes only. Always consult your individual tax, legal, or financial professionals for advice tailored to your situation.
Let's Talk
Finding a better way doesn’t start with you learning about investment strategy. It starts with us learning about you.
Let’s get started.
Contact Us