In this concluding article, I will give my opinion on why I think this debate does not matter and why your investment choices need to align with your goals and preferences.
If you have not already, please read the preceding parts of this series before continuing with this article.
Passive Investing Does Not Exist
Up until this point, I have only made the distinction between active and passive mutual funds at the product level. In reality, active and passive investing are part of a broad spectrum of trading strategies. In this context, the debate is more complicated.
For example, day trading is the most active way to invest. This is someone who buys and sells financial products within the same trading day. On the other side of the spectrum, the most passive way to invest is to buy any financial product and hold it for a long period of time. In these scenarios, the differences are obvious. However, it is possible for an active investor to use passive investments and a passive investor to use active investments. Using the previous examples, the day trader can use passive index funds and the buy and hold investor can purchase an active mutual fund. This shows that there is a large gray area in the active/passive spectrum.
Given these complexities, I believe that true passive investing does not exist. Rather, there are only different shades of active investing. Even the most passive strategy of buying and holding a financial product is still an active decision in and of itself.
Therefore, in my opinion, the debate should not be between active and passive funds. Instead, the debate should focus on different investment strategies and how active and passive investments can play a role in that.
Asset Allocation and Fund Selection
In the study, “The Equal Importance of Asset Allocation and Active Management”, the authors try to determine what factors make up the performance of a portfolio. They found that about 75% of a typical fund’s performance variation was due to general market movement. The other 25% was split between the asset allocation and fund choice. Hence, if you ignore market movements, both the asset allocation and the individual fund are equally important in terms of performance.
In my opinion, this study implies that a proper asset allocation and good selection of funds can make a meaningful difference in performance. Hence, depending on your goals, both active and passive funds can play an important role.
Your Goals Are The Best Benchmark
In the last article, I talked about how measuring an active fund against a benchmark may be misleading. This is because every active fund has different individual characteristics that must be taken into account.
Benchmarking your investments is even more difficult if they are part of an asset allocation. There is no perfect way to compare multiple funds in different asset classes against one benchmark.
In my opinion, your goals are the best benchmark to use. Being mindful of how your investments are keeping you on track toward your goals is more important than what the S&P 500 is doing. Therefore, depending on your goals, active and passive funds can help you achieve them.
There is no one-size-fits-all investment strategy, whether is active management, passive management, or a combination of both. The best strategy is the one that takes into account your goals and preferences.
Based on this reality, I do not think that the debate itself matters. Instead, the investment choices you make need to make sense for you.
The information I provided in this series provides context on how active and passive fund choices play an important role in portfolio performance and risk management. Depending on your financial situation, one might be better than the other.
Ultimately, do not place blind faith in any investment strategy and do not assume everything you read is definitive. Therefore, given the complexity of investing, I believe it is preferable to consult with a financial advisor to determine what strategy is right for you.
I hope this series was informative!