Investing is easy, right? Just use the results of that online risk tolerance quiz you took a few years back to allocate your dollars between a handful of the top-performing index funds, check your statements at the end of each quarter, maybe auto-rebalance every six months — nothing to it.
Er, no. Just, no.
What you just read is a financial advisor’s nightmare — a cartoonish take on the practice of passive investing. No matter how much money you have in the bank or how much (or little) you know about investing, you can do light years better than the poor sap who thinks there’s nothing more to investing than picking the right index funds and…waiting.
Before you get too deep into the weeds, though, make time to understand the absolutely crucial distinction between active and passive asset management. Your financial could depend on your chosen strategy, so pay attention, and don’t hesitate to consult a licensed financial advisor for more guidance.
1. Active Investments May Produce Higher Returns Over Time…
This is true from a 30,000-foot view. Whereas passive investments (funds, managers) are content to match the performance of an underlying benchmark that can go up or down, active investments have more complex objectives, often to include exceeding the performance of the broader market.
2. …But Manager Quality Matters
Not all active investments perform better than comparable passive investments at all times, of course. For active investors, fund quality — and manager quality — is absolutely crucial. That’s why leading financial advisors like San Francisco-based wealth management star Daniella Rand choose best-in-category active funds. Rand and her ilk rightly expect elite fund managers to perform better over time.
3. Evaluating Funds Is Not an Amateur’s Game
Wealth managers like Rand have difficult, grueling jobs. Evaluating funds and institutional money managers is just one aspect, but it’s not one to phone in. No offense — most amateur investors lack the experience and analytic framework to evaluate active funds on the merits.
4. Passive Portfolios May Be Faster to Build…
Our nightmare scenario is a grotesque exaggeration, sure, but it’s not science fiction. Building a passive investment portfolio is easy enough for a layperson seeking exposure to major market indices like the S&P 500. The real difficulty comes on the management side.
5. …But They’re Less Resilient When the Market Goes Down
And, on that front, passive portfolios fall short. Active managers, by contrast, anticipate market downturns, or work to mitigate the damage after they’ve occurred. On neither count do they produce flawless results, but passive fund managers don’t even try; it’s not their job.