Few investment questions stir up more debate than whether it is better to invest with managers trying to beat an index (“active managers”) or better to simply track the index (“passive”). Which is better?
In graduate school, I learned how to analyze individual stocks and decide whether they would make a good investment. At the same time, I would read in the media how low-cost index funds were the smarter way to keep more of your money in your pocket. Studies from the academic world and industry experts create compelling arguments for both sides. Once I started as a financial planner, the noise coming from both sides only got louder and the picture fuzzier.
The truth is that you can make either side look better simply by changing the assumptions you make, the universe you include, and the time period you use. Besides, what holds true in the past may or may not be true going forward (which is why the regulators insist on the ubiquitous statement “past performance is no guarantee of future results”.) The debate quickly becomes a Coke vs. Pepsi preference taste test or a political argument – with both sides convinced they are right.
So if neither is inherently better, what should you do?
- If all things are equal, then obviously low-cost is better than high-cost; however, sometimes paying more gets you more (do you want the features of Honda or a Mercedes?)
- Do not get wrapped up in choosing the “wrong” type of investment. The return difference between active vs. passive funds is rarely significant compared to the differences made by proper rebalancing, proper tax diversification, and other techniques. Focus on what really matters.
- Be open-minded and willing to listen. Most advisers have an opinion and appreciate the opportunity to explain their rationale. It may differ from what you read, but that fact alone should not concern you.
My approach does focus on the reduction of expenses for my clients; however, I am open to utilizing active management when there is a need for something different!
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