Investment Philosophy: Active or Passive?
My kids love Halloween. Scratch that. My kids love wearing costumes and taking on the persona of their favorite superhero. Halloween just makes it normal to adopt an alter ego in public. So, with October 31st just around the corner, we’ve been costume shopping. The saying “like a kid in a candy shop” should be changed to “like a Wright kid in a costume shop”.
As it turns out, at your local Spirit Halloween store, you can find a sword to pair with any outfit. The consequence: sword battles.
The battle for dominance is never-ending. In fact, in recent years it has intensified. Now it’s Optimus Prime versus Ninja. We break up the skirmishes when they get too intense and before anyone gets hit in the eye. Oddly, the conflict isn’t bothersome. It actually feels normal. That’s probably because we deal with conflict every day in almost every aspect of our lives.
Everyday volatility in the stock and bond market comes from conflict too. It’s buyers versus sellers. It’s investors versus traders. Conflict is a feature of the markets, not a bug, and it’s quite healthy. Rivaling viewpoints is how prices are set and how progress is made. If it wasn’t for competition, old ideas would never be replaced by new, better ideas. There would be no growth.
A competing opinion that continues today is whether being an active or passive investor is superior. Choosing to be active or passive is the basis of the investment philosophy you’ll use to build your portfolio.
Unfortunately, the tale the media weaves about passive is wrong. Passive, as it’s portrayed, equals Index Funds. It is true many passive investment philosophies incorporate Index Funds, but many active strategies do as well. A better definition for passive investing is that it’s for investors who aim to keep portfolio activity levels low.
Understanding Investment Choice vs. Portfolio Management
As we define the investment plan to help clients reach retirement or other goals, it is important that clients understand the differences between an investment product and portfolio management. Investment products are instruments such as exchange traded funds or mutual funds. Portfolio Management is the process of putting the products together and managing how those choices will change over time. This difference between product selection and portfolio management forces investors to define their investment philosophy.
Portfolios are built around the investment philosophy and sticking with it is necessary for reaching your goals.
The first step to setting an investment philosophy is your intended activity level. For example, want to react to current news and change your portfolio to take advantage of new trends? You’re probably an active investor. Want to do research and build conviction in your investments and change them infrequently? You’re probably a passive investor.
Active investors who have high activity levels are known as Traders and when they do it with Index Funds they’re known as Tactical Asset Allocators. Passive investors who research and select investments to own for a long-term are called Fundamental Investors. Alternatively, passive investors who use Index Funds are known as Buy-And-Hold Investors.
The second step is defining the implementation method. The two major options are selecting Managed Funds to pick stocks or bonds or choosing Index Funds to track the market.
Index Funds were first created in the 1970’s and attempt to track an underlying benchmark like the Dow Jones Industrial Average. They don’t intentionally select investments and attempt to free-ride on the hard work of Managed Funds. Managed Funds, on the other hand, are run by professional investors, and try to individually select holdings based on certain criteria.
Wright Associates’ Investment Philosophy
At Wright Associates, we believe that your investment philosophy should put the odds of success in your favor. To do that, we use both Managed Funds and Index Funds to build portfolios and try to keep the activity low. Therefore, we abide by an investment philosophy that tries to buy-and-hold. We’re passive in the sense that we try not to change investments all the time.
One reason is that inactivity is the friend of the investor. Returns take a long time to compound and there is no evidence to suggest frequent trading leads to success. When you can stay the course, it’s less likely you’ll interrupt the amazing effects of compounded growth. So, philosophically, we believe less is more when using Managed or Index Funds.
Less does not mean zero, however. Rather than buy and hold, we buy and verify. Our investment process is built to continuously validate the reasons for owning an investment. Reading regulatory filings, conducting manager interviews, and analyzing third-party research keeps us informed. Staying up to date allows us to quickly jump into action when it’s warranted. When things change for the worse, we change our portfolios, while appreciating not every pot hole is a cliff.
Just ask my kids. Most of the time I passively observe their epic sword fights, and they tire themselves out before anyone gets hurt. No reason to get in the way of a good thing, but I’m also the silent referee, intervening before something bad happens.
The Passive Investor is Patient
The passive investment philosophy incorporated into our wealth management process takes the same tact. We’re always watching. So, as buyers and sellers battle in the stock, we build portfolios with the intent to hold for the long-term, only interrupting when something changes for the worse. Our intention is to not chase investment fads and react to every market bump, but to apply sensible strategies to deliver the returns clients need to meet their goals.
Adam K. Wright, CFA, CFP®
IMPORTANT DISCLOSURE INFORMATION
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