Mar 7: What’s the difference between active and passive management?

March 7, 2024

We read all the time about “active” and “passive” management of investments. While it sounds like one type is for those that jog and work out, and the other is for people comfy on their couches, the actual meaning is a little different. Save with SPP had a look around to find a good explainer or two.

Writing for Bankrate via AOL, Dr. James Royal writes that “active investing is what you often see in films and TV shows. It involves an analyst or trader identifying an undervalued stock, purchasing it and riding it to wealth.”

“It’s true – there’s a lot of glamour in finding the undervalued needles in a haystack of stocks. But it involves analysis and insight, knowledge of the market and a lot of work, especially if you’re a short-term trader,” he continues.

On the other hand, he notes, “passive investing is all about taking a long-term buy-and-hold approach, typically by buying an index fund. Passive investing using an index fund avoids the analysis of individual stocks and trading in and out of the market. The goal of these passive investors is to get the index’s return, rather than trying to outpace the index.”

So the Coles Notes on this are as follows – an active management approach involves you (or an advisor) actually picking investments that you think will beat the market’s returns. Passive means you aim to duplicate the market’s returns, usually by buying index funds that consist (unsurprisingly) of all the funds on the various index.

So, is one approach better than the other?

A recent New York Times article suggests that over time, the passive approach tends to work out the best.

“Over the last 20 years, stock pickers have had a dismal record. Most haven’t come close to beating the overall stock market,” writes Jeff Sommer.

“But occasionally, there are exceptions. In some periods, stock pickers rule, and the start of this year was one of those times. In fact, it was the best January for actively managed stock mutual funds since Bank of America began compiling data in 1991. It wasn’t just that they turned in handsome returns for investors. The entire stock market did that. The S&P 500 and other stock indexes set records during the month,” he notes.

The article goes on to say that stock pickers seem to do best when markets are doing the worst – such as the 2008/9 credit crisis. Passive investing does well at most other times, he points out.

A Forbes article on the topic makes the point that active investing requires much more of an effort.

“You can do active investing yourself, or you can outsource it to professionals through actively managed mutual funds and exchanged traded funds (ETFs),” the article notes. However, the article notes, you need to be watching your holdings all the time.

“Without that constant attention, it’s easy for even the most meticulously designed actively managed portfolio to fall prey to volatile market fluctuations and rack up short-term losses that may impact long-term goals,” Forbes reports. “This is why active investing is not recommended to most investors, particularly when it comes to their long-term retirement savings.”

On the contrary, “because it’s a set-it-and-forget-it approach that only aims to match market performance, passive investing doesn’t require daily attention. Especially where funds are concerned, this leads to fewer transactions and drastically lower fees. That’s why it’s a favorite of financial advisors for retirement savings and other investment goals.”

No one likes to talk about investments unless they are winning. It’s like bingo – you hear when your friends win the big jackpot, but otherwise, you don’t. We have heard horror stories from friends who went for the home run with things like Bre-X, or Nortel, or cannabis stocks, and of late, bitcoin.

Whatever approach you personally choose for your own investments, we recommend that you seek the advice of a professional investor. The portfolio you construct on your own may be fine, but will almost always benefit from the oversight of a pro.

If you’re a member of the Saskatchewan Pension Plan, you are already benefitting from professional investment advice. The SPP balanced fund returned 7.73 per cent, on average, since its inception more than 35 years ago. While past returns are of course no guarantee of future rates of return – no one can predict the future – it’s nice knowing that SPP’s investing history has been so positive. Check out SPP today!

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Written by Martin Biefer

Martin Biefer is Senior Pension Writer at Avery & Kerr Communications in Nepean, Ontario. A veteran reporter, editor and pension communicator, he’s now a freelancer. Interests include golf, line dancing and classic rock, and playing guitar. Got a story idea? Let Martin know via LinkedIn.

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