Active Funds vs. Passive Funds: What Fits Your Portfolio?

Now that 2015 is behind us, money managers are noticing a significant shift in the way clients managed their money last year. As a group, these individual investors put more into so-called passive funds and withdrew from active vs passive funds

This comes at a time when active funds are coming under increased scrutiny for the fees they charge, effectively for the expertise of a hopefully experienced fund manager who will use research and skill in an attempt to beat the market. But it also comes after a year that provided proof that stocks don’t always go up.

It’s a question worth considering but it’s also one that may not yield a simple answer. Here are some factors to consider:

Are you an active investor? In the simplest terms, actively-managed funds may often be good for the more passive investors who want to invest and forget it. One of the things you’re paying for in an active fund is a quick, informed response to changes in market conditions. So, for example if you’re investing strategy is based on the major blue-chip stocks and then the Dow Jones Industrial Average starts to tank, a passive fund indexed to the Dow would pretty much follow course, while the active fund manager might change strategy. This active approach can be good for individual investors who don’t want to have to “babysit” their stocks.

What are your goals and what is your time frame? Are you seeking to buy and hold for a retirement that is years in the future? Or, are you trying to make a quick profit? Here at Wyatt we talk often about the benefits of buying and holding for the long term. If that is your plan, passive funds may work fine for you. We know that, although markets rise and fall, over time they go up. So should passive funds if you hold them long enough. On the other hand, if you’re trying to beat the market, you may need some assistance.

You don’t always get what you pay for. Of course, one of the best reasons to go with an active fund, in theory at least, is that you’re paying for a skilled investor. But buyer beware: Not all actively-managed funds perform well in all circumstances. In truth, there is a huge range in price and performance among active funds and even a single fund will typically have up years and down years. So, even if you’re looking for an investment tool that will work for you, you’ll have to do a lot of research up front to understand what you’re buying and the value you’re getting.

Diversification is important. Much more important than the type of any individual fund that you buy, is that you don’t but all your metaphorical eggs (dollars) in the same basket (funds). The best portfolios are diversified by investment tools and sectors. Ideally, once you’ve determined your own personal appetite for stocks, you should invest in a variety of stocks and/or funds, not a single fund.

A combination of active funds and passive funds could be a smart way of diversifying but you should also think about the sectors that interest you. A combination of funds focused on small caps, large caps and emerging markets will bring diversity even if the individual funds are all passive.

In short, while it is worth contemplating the pros and cons of active funds and passive funds, it is critical to understand that you can find a lot of winners and losers in both buckets. And for that reason, even the most passive investor will have to do a fair amount of research up front.

If you are willing to pay for investment expertise and guidance, make sure you are paying a fair price for a good product. If you prefer the lower-cost passive route, understand that it takes work to build a portfolio that you won’t have to monitor daily – and it may take time to see rewards. That’s not always a bad thing. Slow and steady really can win the race.

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Published by Wyatt Investment Research at