TRANSCRIPT:
Passive versus active management is one of the most highly debated topics in wealth management. Today, we’re going to go over the pros and cons of each and give you my opinion on which style is best. Hi, I’m Alex Wolf, certified financial planner and head of financial planning at Base Wealth Management. In our video today, I’m going to go over two different investment philosophies and which you should use.
In the world of investing, there are two main approaches to investing your money. One method is active management. Active management is where you select an ETF or mutual fund where the fund manager is making tactical decisions on what stocks or bonds they hold inside the fund. They’re actively making changes to the portfolio based on data, economic information, and, of course, the stock or bond information on those companies. Active management is also typically more expensive, as you are paying the fund manager to try and outperform the markets or indices.
The other method is passive management. The best example of passive management is an S&P 500 ETF or mutual fund. The fund manager invests the portfolio into this basket of securities based on the S&P 500. The only real changes happen when stocks get added or removed from the index. The rest of the adjustments are from the natural appreciation or decline of the individual holdings in that index or fund.
So, which is ultimately better? That is the question many investors and money managers discuss. The real answer, as I’m sure you may have already started to develop, is it depends. In certain markets, passive management can lead to better returns, and in other cases, active management outperforms. There are also certain sectors where passive management often outperforms active management, and the difference in returns is very minimal. For example, in the large-cap stock market, there is normally a small difference in active versus passive returns. This generally is thought to be the case because of how efficient that area is. When it comes to other stock styles, such as small-cap or international, this is where active management more often than not outperforms passive management.
Now, to get to the good stuff, what do I think? Well, I’m a very data-driven investor and let the data guide me to making a decision. When reviewing what we have discussed and the data of active versus passive, I follow the same approach when investing in creating a portfolio. I use a blend of active and passive management. In most cases, I use passive for large-cap stocks and active for small-cap, mid-cap, and international. We also tend to favor active management with our bond managers.
2022 taught many investors a valuable lesson in the bond market. Investing just in the bond aggregate index saw one of the largest single annual declines in history. Active bond management fared a little better as managers were able to make adjustments to find areas of the bond market that would better weather the rising interest rates.
If you found this video helpful and would like to get more financial planning and investment content, please hit subscribe and hit the notification bell to get alerted when new videos come out. I’m Alex Wolfe, certified financial planner at Base Wealth Management, and we’ll see you next time.
