Passive Investing: Level-Headed or Lazy?

Does passive investment management merit its “couch-potato” nickname or is it not getting the respect it deserves?

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Passive investment management may be the Rodney Dangerfield of financial strategies – it gets no respect. Active investment strategies have had the spotlight so long, some investors may be surprised to find there is an alternative to stock picking, market timing and other faster-paced, more glamorous methods.

Active investment management uses research, investigation and analysis to select investments that the selector believes will outperform the general market indexes. Passive investment management invests in broad market sectors and accepts the average returns those sectors produce.

The research, investigation and analysis inherent in active investment management come at a cost. Active management usually results in higher turnover within the portfolio, potentially generating trading costs, commissions and taxes. Those costs should be calculated against the higher gains that active investing may have over a passive strategy; in other words, is the potential for additional gain worth the near-certainty of additional cost.

Passive investing seeks to take some of the prognostication out of the investment process, as well as the possible emotional impact. Daily evaluation and re-evaluation of investments can cause you to overlook more subtle trends and to lose sight of your personal big picture. It’s easy to get caught up in the next great investment pick or strategy. Ignoring the hype in favor of the buy-and-hold tactic may help keep your portfolio on course.

Passive investment management does not, however, mean purchasing investments and then ignoring them. Your portfolio will need to be rebalanced periodically to make sure those sectors performing better than expected don’t become too great a share of your invested assets. Changes in your personal life – marriage, children, divorce, death of a spouse – may also necessitate changes to your investment plan.

Neither does it mean foregoing the assistance of an investment professional or financial advisory team. These professionals should help you determine your investment goals, the amount of money needed to reach them and the best strategies for accumulating that money. They play an important role in keeping you on the right course, especially when deviating becomes most tempting.

All investments involve risk, whether selected as part of an active strategy or a passive one. Passive investing does not “loss-proof” your portfolio. On the flip side, past success is not indicative of future performance, as active-style proponents might have you believe.

In the end, you have to weigh the lower costs, style consistency and tax efficiency of a passive investment strategy against the potential greater returns of an active investment strategy. Your financial advisor can play an important role in helping you determine which style best suits your investment time horizon, risk tolerance and investment experience.