Investors frequently diversify their portfolios between stocks, bonds, and cash, and also between different sectors of the economy and in securities from a variety of countries around the world. However, an important but often overlooked type of diversification is active and passive management.
“Active management” means the investor actively chooses the individual holdings for his portfolio. If your asset allocation model calls for “large cap stocks,” you would choose specific stocks or a particular mutual fund that invests in this sector.
Active management requires careful research before purchasing and constant watching to determine when and why to sell. An active investor might choose to hire a money manager to watch and actively trade the portfolio. Some actively managed funds have higher returns than passively managed funds and some don’t, but keep in mind that the costs of active management will directly impact your returns.
With passive investing, within the framework of your asset allocation model, you might choose an Exchange Traded Fund (ETF) / index fund that fits your criteria, such as “growth funds,” “global real estate,” or “corporate bonds.” You don’t choose the specific investments within the portfolio – just the type of fund that interests you. Passive investors give up directing all of the minutia for the comfort of knowing the overall mix of investments matches their desired asset allocation. Typically, passively managed funds’ fees are lower than those of actively managed funds because they don’t have as much trading going on and because there are no management teams that need to be paid.
Which is best?
Like many other investment decisions, it depends on you. One common tactic is to diversify your portfolio between active and passive investments.
Having nearly three decades of experience in teaching clients about diversification in their investment portfolios, I welcome you to be in touch (email@example.com or call 02-624-2788) if you want help determining a suitably diversified asset allocation model for your investments.
For more information about how to choose a money manager, click here to watch a short clip about Separately Managed Accounts.
Douglas Goldstein, CFP®, is the Director of Profile Investment Service, Ltd., which specializes in helping people who live in Israel with their US dollar assets and American investment and retirement accounts. He helps olim meet their financial goals through asset allocation, financial planning, and using money managers.
Published September 14, 2015. Updated October 2020