Whether it’s sports, music, or politics, life holds any number of “great 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, the argument goes, is true for two primary reasons:
- 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
- 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 be properly reflected 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% of the index return at 70% of its risk, then that constitutes a measured 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 methods 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.
- 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.
- This is a hypothetical example used for illustrative purposes only. It is not representative of any specific investment or combination of investments.