MAKING CENTS: Active or passive investing requires attention

When building an investment portfolio, there are two considerations regarding how you may construct and monitor that portfolio. One is with active management and the other is passive management. Neither is right or wrong, and the current condition of financial markets may favor one over the other from time to time, yet some investors are passionate about their methodology to a fault.

Receiving a lot of attention over the past decade or so is passive investing. The primary argument that indexers raise is that few investors actually outperform indices and they are often a lower cost alternative than their actively managed counterparts.

The premise with passive investing is kind of like a set it and forget it style. Passive investors typically invest in index based products. Some are broad based indices such as the Standard and Poor’s 500 index while others may represent a specific sector, industry or region. Within the indexed investment product of your choice, the manager will frequently own literally every single stock that makes up the particular index.

This means that you will participate in the gains from that index as well as the losses. This feels great in good times, but when your index is not performing, you’ll also receive 100 percent of the down side of that index.

When a passive approach is utilized, most investors would benefit from actively managing their basket of indices held in the portfolio. Your active management may be as simple as regular re-balancing or as sophisticated as altering your allocations based on market conditions within the particular market, sector or region that you hold. This is particularly important if your index selection has you owning very specific and volatile sectors such as energy or emerging markets.

Active management, on the other hand, is when you or a fund manager is actively trying to manage the holdings within a portfolio to select what the manager feels are the best choices for appreciation and the least probability of losses. While the statistics for individual investors do indicate that do it yourselfers have not often fared well with their actively managed choices, the same is true for passive do it yourselfers.

In any economic environment, some choices will win and some will lose. Even during tough economic times, certain companies will out compete others, and gain market share and profitability – the underpinnings of value. Consequently, one would expect these out-competers to also out-perform over the long haul.

What investors should care about is net results. Are your net results meeting your needs and goals? Do you even know what you need to earn on your investments to meet your life’s goals and dreams? Managing your investments to meet your required rate of return is what you should be focused on and not benchmarking to a specific index. In fact, benchmarking to a broad index such as the S & P 500 or the Dow 30 is inappropriate for most investors because most investors do not, and should not own all U. S. large cap stocks.

John P. Napolitano is CEO of U.S. Wealth Management in Braintree, Mass., and 2012 president of the Financial Planning Association of Massachusetts. He may be reached at jnap@uswealthcompanies.com or on Facebook as JohnPNapolitano and US Wealth

John Napolitano is a registered principal with and securities offered through LPL Financial. Member  FINRA/SIPC. He can be reached at 781-849-9200.

Securities offered through LPL Financial, Member FINRA/SIPC.

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