Active vs. Passive Management
When planning for retirement, selecting the right investment funds can be a complex decision. At Fortress Financial Group, we strive to simplify this process by providing clear and concise information. Let's explore the differences between actively managed and passively managed funds.
Understanding Actively Managed Funds
Actively managed funds are overseen by professional managers who make decisions about buying and selling securities to outperform a specific benchmark, such as the S&P 500. These managers use their expertise to identify investment opportunities, aiming to achieve higher returns or mitigate risks.
History of Actively Managed Funds The concept of actively managed funds dates back to the early 20th century when mutual funds were first introduced. One of the earliest examples is the Massachusetts Investors Trust, founded in 1924, which aimed to provide individual investors with professional management of diversified portfolios¹.
Pros of Actively Managed Funds:
Potential for Outperformance: Skilled managers may deliver returns that exceed the benchmark.
Risk Management: Managers can adjust the portfolio to protect against market volatility.
Cons of Actively Managed Funds:
Higher Fees: Active management involves higher costs due to research, trading, and management fees.
Underperformance Risk: There's a risk that the manager's decisions may lead to lower returns compared to the benchmark.
Understanding Passively Managed Funds
Passively managed funds, also known as index funds, aim to replicate the performance of a specific index, such as the S&P 500, by holding the same securities in the same proportions as the index. These funds do not involve active decision-making but follow a predetermined strategy.
History of Passively Managed Funds The first index fund, designed for institutional investors, was introduced by Wells Fargo in 1971. However, it was Vanguard's launch of the first index mutual fund for individual investors in 1976, the Vanguard 500 Index Fund, that popularized passive investing².
Pros of Passively Managed Funds:
Lower Costs: With no active management, these funds typically have lower fees.
Consistent Performance: Passive funds aim to match the performance of their target index, which historically has shown long-term growth.
Cons of Passively Managed Funds:
Limited Upside: These funds are unlikely to outperform the market since they aim to replicate it.
No Risk Mitigation: Passive funds do not adjust their holdings based on market conditions, so they do not offer protection against downturns.
Choosing Between Active and Passive Funds
Deciding between actively and passively managed funds depends on your investment goals, risk tolerance, and preferences. Some investors prefer the potential for higher returns offered by active management, while others favor the lower costs and simplicity of passive funds.
Performance of Active Managers
Studies have shown that a majority of active managers fail to outperform their benchmarks over the long term. According to the SPIVA (S&P Indices Versus Active) Scorecard, approximately 75% of active large-cap managers underperformed the S&P 500 over a 10-year period³. However, in the small-cap sector, active managers have a better track record, with about 35% outperforming their benchmarks over the same period⁴.
Fortress Financial Group's Approach
At Fortress Financial Group, we dedicate significant resources to researching fund managers and identifying sectors that may benefit from active management. Our team conducts thorough due diligence, evaluating managers' track records, investment strategies, and market insights. We focus on sectors where active management has historically added value, such as small-cap stocks, where the inefficiencies in the market can create opportunities for skilled managers to outperform the index.
Diversified Approach: Many investors choose to include both types of funds in their portfolios, balancing the potential benefits and risks.
Consult a Financial Advisor Selecting the right mix of funds for your retirement portfolio is crucial. At Fortress Financial Group, our financial advisors in Rochester, Minnesota, are fee-only fiduciaries dedicated to providing unbiased advice. We help you understand your options and develop a strategy tailored to your needs.
Conclusion Understanding the differences between actively managed and passively managed funds is essential for informed investment decisions. By knowing the pros and cons of each, you can choose the approach that best aligns with your retirement goals. If you have more questions or need personalized advice, visit our website at fortressfg.net to schedule a consultation with one of our experienced advisors.
Disclosures:
Fortress Financial Group LLC (“FFG") is a registered investment advisor. Advisory services are only offered to clients or prospective clients where FFG and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at https://fortressfg.net/. For current FFG information, please visit the Investment Adviser Public Disclosure website at www.adviserinfo.sec.gov by searching with FFG’s CRD# 315329.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
References:
¹ Massachusetts Investors Trust. (n.d.). Retrieved from Massachusetts Investors Trust
² Vanguard. (n.d.). The Vanguard story: A history of innovation. Retrieved from https://corporate.vanguard.com/content/corporatesite/us/en/corp/articles/history-of-innovation-vanguard-story.html
³ S&P Dow Jones Indices. (2023). SPIVA U.S. Scorecard. Retrieved from https://www.spglobal.com/spdji/en/spiva/article/spiva-after-tax-scorecard/
