In recent years, there’s been a considerable debate about which is better, active or passive investing.
Most people narrowly define them as the following:
- Active: Someone, usually a mutual fund manager, picks and chooses investments for you,
versus
- Passive: You just own an existing group of investments (that someone has already picked out)
These are fine delineations IF you’ve already decided on an area to invest in. For example, let’s say you want to buy mid and large-sized U.S. companies. The typical choice using the definitions above is to either:
- Active: Select a mutual fund manager who may purchase ~20 to ~200 companies for you alongside their other investors. They decide what you own (or not)
OR
- Passive: Purchase a fund that tracks the closest index, such as the S&P 500. The index already exists and, in this case, owns many large (~500) public companies in the United States.
So, there’s a start at what many people consider active versus passive. As you keep reading, you’ll realize there’s much more to know and care about.
History
Passive investing is “newer” in the investment world. Vanguard’s founder, John Bogle, launched the first mutual fund that tracked an index (in this case, it was the S&P 500) in 1975. It wasn’t until 1993 that an investor could trade or exchange this fund throughout the day (versus buying or selling once per day). That’s when State Street created its SPDR exchange-traded fund.
We believe passive investing has had a hugely positive effect on investors’ returns. After all, one thing you can control is how much you pay for something. According to the Investment Company Institute, investors in stock funds back in 1990 paid, on average, almost 2% of the balance in mutual fund fees and expenses. [1] That’s not even mentioning brokerage fees, commissions, or other fees layered on top.
Today, State Street offers the opportunity to invest in the S&P 500 for just 0.02%.[2] That is a whopping 99% LESS than the cost in 1990! Moreover, you can now open accounts and trade in them basically for free.
Passive’s Limitations
There are limits to passive investing—less control and customization. You can own a fund that tracks the S&P 500 but can’t influence which companies are part of it. Even if you don’t want to own fossil fuel or tobacco companies, you’ll still end up buying them. It’s impossible to build a custom portfolio focusing on companies you want to own and those you don’t.
You also can’t control how much you own of each company. Even though you have diversification across hundreds of companies, as of this writing, about one-quarter of what you own would be in five technology-related companies (Microsoft, Apple, NVIDIA, Amazon, and Alphabet).
We’d much prefer to have control over WHAT we own (and HOW MUCH of it we own).
Conclusion
So, what does this mean for you?
Recognize that you’re ALWAYS making ACTIVE investment decisions.
Imagine someone gives you $100,000—what do you do with it? Everything is an active decision. You could stuff it under your mattress, buy a house, buy gold, deposit it at the bank, travel the world, buy stocks, etc.
If you buy stocks (and invest for the future), do you buy small or large companies, those in the U.S. or abroad, or those that are technology or consumer-based? The decision-making goes on and on and on. That’s the point.
Now that it’s obvious that everything is an “active” decision, what is the best option for building wealth for the future? In the next few posts, we will answer that question by reviewing why active management hasn’t worked for individual investors and then sharing what our team does in the pursuit of superior returns.
Read the Value of ACTIVE Investment Management – Full Series
- Part 1: ACTIVE versus Passive (this post)
- Part 2: Why hasn’t ACTIVE management worked (for individual investors)?
- Part 3: Striving for superior ACTIVE returns (what JSA does differently)
[1] https://www.ici.org/pdf/2010_factbook.pdf
[2] https://www.ssga.com/us/en/intermediary/etfs/funds/spdr-portfolio-sp-500-etf-splg
