Brad Tinnon

Brad Tinnon

Active vs Passive Investing – Do You Know The Difference?

Recently I blogged about the importance of no longer using Mutual Funds.  One of the reasons for making this bold statement is that Mutual Funds are often times actively managed investments and as a result incur unnecessary taxation and cost.

You see, one of the most important decisions you have to make is whether to use active or passive investments within your portfolio.  But, my guess is that you didn’t even know that a choice existed. Read on as I explain the active vs passive investing debate.    

An active investment is one that has a manager.  For example, many Mutual Funds have managers tied to them.  The manager’s job is to pick the right stocks at the right time.  They also are responsible for trying to invest into the next best sector (i.e. energy, banks, technology, etc…).  Essentially their job is to speculate.  The proponents of active management call this research, but I prefer to use the term speculation.

A passive investment does not have a manager.  It is just a composition of a particular investment category (also called an index).  For example, the Dow is a composition of 30 “large US stocks”.  Or the S&P 500 is a composition of the “500 largest stocks in the U.S.”  There are formulas that determine how a stock makes its way into the Dow or S&P 500, but there are no managers.  Why is this important?  Keep reading…..

In the most simple way I can describe, active investments are typically much more expensive than passive investments mainly due to the fact that a manager exists.  Additionally, because this manager is responsible for constantly buying and trading stocks (or bonds), significant taxation and trading costs will likely apply.  And, higher costs can ultimately eat into your returns.  Once again, I encourage you to check out our previous blog on Mutual Funds to learn more.

Did you know that the vast majority of active investments do not outperform passive investments?  This would naturally make you wonder why you would want to pay a manager a fee when they don’t typically outperform.  This is precisely why we primarily do not use actively managed investments within our portfolios.

Our approach to investing is based on decades of academic and Nobel Prize winning research.  Essentially what I am talking about here is diversification.  This is just a fancy way of saying that we place our clients’ investments in many different buckets (i.e. investment categories).  In fact, we own thousands of different stocks and bonds within our clients’ portfolios.

If you’d like to learn more about active vs passive investing or if you are unsure what type of investments you own, feel free to reach out to us.  We will be happy to assess your portfolio at no charge.  Here’s to making you a more “informed investor”.

Brad E.S. Tinnon, Owner
CERTIFIED FINANCIAL PLANNER™

P.S.  We would love to hear any comments you have.  Please list them below.  Also, if you’re just finding our blog for the first time, feel free to sign up for our eContent.

 

photo courtesy of www.stockmonkeys.com

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