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Active vs. Passive Investing
" [Most investors would] be better off in an index fund." Peter Lynch, famous stock picker, Barron's, p. 15, April 2, 1990
There are basically two fundamental investment management strategies available to investors: Active and Passive/Indexed.
Active management is broadly defined as the process of researching and picking the best stocks to buy, or hiring a professional fund manager to do it for an investor. Implicit in this strategy is the belief that well-chosen securities will produce better returns than those securities chosen without extensive screening and research.
Active managers constantly reevaluate their portfolio holdings in an effort to only keep the securities that they believe will prosper in the economic environment and exceed the returns of the other securities. Identifying these securities to buy requires substantial time analyzing a large amount of data available on thousands of individual stocks, which includes financial statements, market trends, management competence, and industry structure. By the time investors add in the cost of this research, the transaction costs and taxes, active management becomes a very expensive investment approach. As a matter of fact, studies of money manager performance over the past fifty years offer convincing evidence that active managers as a group have been unable to generate investment returns sufficient to recoup these costs and extract market-beating profits.
"I'd compare stockpickers to astrologers . . .
but I don't want to bad-mouth the astrologers."
-Eugene Fama
Passive/Indexed management, on the other hand, makes no forecasts of the stock market or the economy, and makes no effort to pick securities. A passive manager makes no determination if company A is better than company B. Instead, he or she simply buys everything from A to Z in their defined asset class resulting in a portfolio with hundreds of stocks. Portfolio adjustments are made only in response to changes in the underlying universe or index – for instance, a small cap company grows into a large cap company or an index adds or removes a security from its basket of holdings.
Passive investing by its very nature is low cost (no research department), tax efficient (little turnover) and generally useful in projecting expected asset class returns over investment horizons greater than 5 years (produces asset class returns).
"..the best way to own common stocks is through an index fund..."
-Warren Buffett, Berkshire Hathaway, Inc.
At Fischer & Hutchinson Wealth Advisors, LLC, we are strong advocates of the passive philosophy of investing. It is our belief that academic and professional research provides evidence that passive investment strategies offer long-term portfolio returns superior to those available from active money managers. Passive funds allow investors the opportunity to most effectively maximize their assets through a low cost, tax efficient, market return investment strategy.
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