Active or Passive? Stocks or funds?By Randell Tiongson on May 7th, 2019
What strategies should you use to invest your money?
Individual preferences create issues and choices in the way investments are managed. Two of them-active versus passive investing and use of individual securities versus mutual funds or UITFs?
An Active versus Passive Approach
Risk-return and efficient market theory says that attempting to outperform the market will not be fruitful. If you manage to do so, you are just lucky, not skilled. This thinking leads to a passive approach to investing. With a passive approach, no attempt is made to receive greater-than-market returns. Its proponents believe efforts can better be used to diversify in order to reduce risk and keep costs low. Passive investors tend to purchase index mutual funds of all types. An index fund attempts to duplicate market performance and keep costs low by using computerized programs to purchase holdings and not employing high-priced investment managers and analysts.
With the alternative, the active approach to investing, changes are made in holdings over time to take advantage of new opportunities. There are many different ways of performing active investing. However, they all have as their basis the belief that it is possible to outperform the market. Otherwise, it would be silly to make the effort.
One prominent active approach is fundamental investing. Under fundamental investing, analysis is made of overall market, industry, and company data to identify opportunities. Often the basis of this approach is the belief in mean reversion in investments with purchases made at below “true value” levels and sales made when they return to or attain correct valuations.
Individual Securities versus Mutual Funds / UITF
In establishing an investment portfolio, a decision should be made about whether to use individual securities or mutual funds. Individual securities purchased by the household involve no fund-overhead expenses and offer a greater ability to buy and sell for tax planning purposes instead of typical annual taxable capital gains for mutual funds. With individual securities, there also can be the emotional “high” of watching a stock in your portfolio do well.
Mutual funds and/or UITFs offer professional advice at reasonable cost, the ability to delegate the investment management and record-keeping function, and simple diversification with low investment minimums by specialists in a wide variety of types of securities, geographic areas, and styles of investing. One of the risks in these investments is that it can underperform the market at certain times.
Given the lack of expertise in many households, the lack of desire to monitor their investments, a sometimes-emotional response to buy and sell decisions, and a desire for lower volatility, the majority of financial planners recommend implementing through pooled funds such as mutual funds our UITFs.
There are no perfect investment strategy just are there are no best investments. Do not forget to diversify and always be prudent with your investments.