The Active vs. Passive Discussion in Funds versus Portfolios

Introduction: In the world of investment management, two primary approaches dominate the landscape: active and passive management. These strategies dictate how investment funds and portfolios are managed, each with its own set of philosophies, advantages, and drawbacks. Understanding the differences between active and passive management is crucial for investors looking to make informed decisions about their financial futures. Much has been written and discussed about “active vs. passive” investing, and as a result, the difference in using an actively managed mutual fund versus employing an active strategy to manage a portfolio gets overlooked. This blog post aims to clarify and highlight some important differences in the discussion about active vs. passive investing.

Fund Management

There are typically two types of investment funds that an investor may choose to use in their portfolio: Mutual Funds or Exchange Traded Funds (ETF). Mutual Funds typically employ an active investment strategy, which involves a hands-on approach to selecting and managing investments within the fund. Fund managers aim to outperform a specific benchmark or index by making strategic investment decisions based on market research, analysis, and their expertise in an effort to outperform their market benchmark. This approach typically entails higher fees due to the active management involved.

Key characteristics of active fund management include:

1. Research-Driven Selection: Fund managers conduct in-depth research to identify investment opportunities they believe will outperform the market.
2. Dynamic Adjustments: Managers frequently buy and sell assets within the fund to capitalize on market fluctuations and emerging trends.
3. Higher Costs: Active management involves more extensive research, trading, and managerial expertise, leading to higher fees for investors.

Exchange Traded Funds or ETFs typically utilize a Passive investment strategy, also known as index investing, aiming to replicate the performance of a specific market index or benchmark. Instead of relying on active decision-making, passive funds aim to mirror the composition and performance of a predetermined index. These funds typically have lower fees compared to actively managed funds.

Key characteristics of passive fund management include:

1. Index Replication: Passive funds aim to closely track the performance of a chosen index by holding the same securities in similar proportions.
2. Low Turnover: Since passive funds seek to replicate an index, there is minimal buying and selling of securities, resulting in lower transaction costs.
3. Lower Fees: Passive funds generally have lower management fees compared to active funds due to the reduced need for ongoing research and management.

Portfolio Management

Active Portfolio Management: Active portfolio management involves making strategic asset allocation decisions within an investor's portfolio to achieve specific investment objectives. Portfolios can be constructed using all mutual funds, ETFs, or a combination of the two.

Portfolio managers actively adjust the allocation of assets based on market conditions, economic outlook, and individual investor goals.

Key characteristics of active portfolio management include:

1. Strategic Asset Allocation: Portfolio managers actively allocate assets across various asset classes, such as stocks, bonds, and alternative investments, to optimize returns and manage risk.
2. Tactical Adjustments: Managers regularly review and adjust the portfolio's composition in response to changes in market conditions or economic outlook.
3. Customized Solutions: Active portfolio management allows for customization based on the investor's risk tolerance, time horizon, and financial goals.

Passive Portfolio Management: Passive portfolio management, often referred to as buy-and- hold investing, involves constructing a portfolio based on a predetermined asset allocation strategy and maintaining it over the long term. Instead of tactical adjustments, passive portfolio managers focus on a strategy of occasional rebalancing back to a predetermined asset allocation.

Key characteristics of passive portfolio management include:

Static Asset Allocation: Passive portfolios adhere to a predetermined asset allocation strategy, typically based on the investor's risk profile and investment horizon.

Infrequent Rebalancing: Unlike active portfolio management, passive portfolios require less frequent rebalancing since the asset allocation remains relatively stable over time.

Minimal Trading: Passive portfolio management typically involves less trading. Depending on whether the account is subject to transaction fees/commissions, a passive portfolio management approach may incur lower fees and trading costs compared to active management.

Combining these strategies results in a portfolio that falls somewhere on this continuum:

Active and passive management strategies offer distinct approaches to managing funds and portfolios, each with its own set of benefits and trade-offs. While active management aims to outperform the market through research-driven decisions and dynamic portfolio adjustments, passive management seeks to replicate market returns at a lower cost through index investing and buy-and-hold strategies.

So, which is better, active or passive investing? As we’ve outlined, the answer might not be as straightforward as one might think. Ultimately, the choice between active and passive management depends on individual preferences, investment objectives, and market conditions. One way to think of it could be: As an investor, do you want to give yourself the chance to outperform the market over time? If the answer is yes, then some level of active portfolio management could make sense. As highlighted in the above continuum, achieving a cost-conscious portfolio with a professional advisor is possible for the investor who does not have the time, energy, expertise, or desire to DIY their investment management.

Opinions expressed in the attached article are those of the author and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice. Prior to making an investment decision, please consult with your financial advisor about your individual situation.

Investing involves risk and you may incur a profit or loss regardless of strategy selected,including asset allocation and diversification. Any information is not a complete summary orstatement of all available data necessary for making an investment decision and does notconstitute a recommendation. Investors should carefully consider the investment objectives, risks, charges and expenses of mutual funds and ETFs before investing. The prospectus and summary prospectus contains this and other information about mutual funds. The prospectus and summary prospectus is available from your financial advisor and should be read carefully before investing.