Whether it’s sports, music, or politics, life holds any number of “great debates”– debates that never seem to reach a conclusion. In investments, that great debate asks the question, “Active or Passive Investing: Which is Better?”
The fascinating aspect of this debate is that equally intelligent people can argue polar opposite positions, leaving the rest of us to wonder what the answer is, if one even exists.
The case for passive management is anchored in the evidence that the preponderance of money managers have failed consistently to beat their comparative index. This is true for two primary reasons:
1) Markets are efficient and all known information is already reflected in the price of the stock, making it difficult for managers to find companies that are expected to outperform.1
2) The hurdle of an elevated expense ratio typical of actively managed mutual funds makes it hard to match or exceed a low-expense index fund.
Active managers counter that while the markets may be generally efficient, there are windows of inefficiency created by the time it takes for information to properly reflect in a stock’s price.
Active managers further argue that performance is not just about relative return, but also about managing risk. For instance, if an active manager can deliver a hypothetical 90 percent of the index return at 70 percent of its risk, then that constitutes a measure of outperformance.2
Unlock the Combination
Ultimately, it’s a decision based on what you want to pursue. Do you prefer the approach taken by index funds or the strategy behind active management? For some, the combination of both funds represents an approach that takes no sides but seeks to tap into the distinctive benefits each offers.
Mutual funds are sold only by prospectus. Please consider the charges, risks, expenses and investment objectives carefully before investing. A prospectus containing this and other information about the investment company can be obtained from your financial professional. Read it carefully before you invest or send money.
International investments carry additional risks, which include differences in financial reporting standards, currency exchange rates, political risk unique to a specific country, foreign taxes and regulations, and the potential for illiquid markets. These factors may result in greater share price volatility.
1. Keep in mind that the return and principal value of stock prices will fluctuate as market conditions change. And shares, when sold, may be worth more or less than their original cost.
2. This is a hypothetical example used for illustrative purposes only. It is not representative of any specific investment or combination of investments.