Financial Planning

The Solution to the Active vs. Passive Investment Management Debate Isn't Either/Or

Retirement savers can put the good points of both systems to work with "core-satellite investing."

In every great debate, there’s a middle ground, and often it’s home to a good compromise.

Unfortunately, when the believers on either side are positive they’re right, that midway point is roundly and routinely ignored. And the dispute rages on.

The two sides of the active vs. passive portfolio-management feud aren’t exactly the Hatfields and McCoys, but they do seem unwilling to give an inch when discussing which is better for investors. It’s been a hot issue in the financial industry for years now, and appears to be an increasingly popular TV and radio topic.

My clients ask me about the differences all the time, and they want to know which is better. I tell them I can’t get decisively behind one side or the other.

Pros and cons of active and passive investing

With an actively managed portfolio, a manager tries to outperform a given benchmark index (such as the S&P 500) by watching market trends, changes in the economy, political maneuverings, etc., to decide when to buy and sell investments.

Passive portfolio management involves matching a specific index’s benchmark performance in order to generate the same return. There’s no attempt to pick and choose — it’s an all-in approach.

At first glance, it seems the active path would be the hands-down winner with investors. Who doesn’t want to think there’s somebody out there carefully tending to their precious nest egg — managing risk and adding value by making all the right moves when necessary?

The problem, of course, is all that extra effort — watching, researching, frequent trading — generates more fees. The fund manager has to make more money just to cover those costs — and then make even more to outperform the comparable index fund. Those trades also can trigger capital gains that will end up going on your tax return even if you don’t actually see the money.

A better approach: Core-satellite investing

This is where the middle ground, the compromise, comes in — what is often referred to as core-satellite investing.

This hybrid method of portfolio construction is designed to minimize your exposure to costs, market volatility and potential tax consequences, but it also offers an opportunity to outperform the market.

The majority, or “core,” of the portfolio is made up of cost-efficient passive investments that track a major market index. The “satellites” are positions added in the form of actively managed investments that have the potential to boost returns and lower risk by further diversifying your holdings.

In uncertain times like these — with the Fed penciling in more interest rates for this year, a record-setting bull market that has to end sometime, a new administration that has Washington, D.C., reeling, and the threat of terrorism around the world — this is an approach I can get behind.

There’s no need to think of this as an either/or argument. Investors can benefit greatly by combining both management methods.

Talk to your adviser about how core-satellite investing might give you some added flexibility while still working within the risk parameters of your portfolio.

Kim Franke-Folstad contributed to this article.

About the Author

Dan Webster, Registered Financial Consultant

Co-Founder, Fusion Capital

Dan Webster originally hails from Rochester, N.Y., and currently resides in Pawleys Island, S.C. He is a Registered Financial Consultant and is a member of the International Association of Registered Financial Consultants and the Financial Planning Association.

Most Popular

Retirement: It All Starts with a Budget
personal finance

Retirement: It All Starts with a Budget

When you’re meeting with your financial planner, do you talk about your budget? If not, you should.
November 10, 2020
Planning to Sell Your Home in Retirement? Downsize Costs Along With Space

Planning to Sell Your Home in Retirement? Downsize Costs Along With Space

In this hot real estate market, consider the costs of buying and selling a house along with the expenses associated with your new digs.
November 13, 2020
What Biden Will Do: 24 Policy Plays to Expect From the Next Administration

What Biden Will Do: 24 Policy Plays to Expect From the Next Administration

The Kiplinger Letter forecasts President-Elect Joe Biden’s biggest priorities -- and the likelihood of progress on them.
November 19, 2020


Protection for Your Assets
wealth management

Protection for Your Assets

At a time when Americans’ savings are soaring, you need to know how your money is insured.
October 29, 2020
18 States With Scary Death Taxes

18 States With Scary Death Taxes

Federal estate taxes are no longer a problem for all but the extremely wealthy, but several states have their own estates taxes and inheritances taxes…
October 19, 2020
Considering Early Retirement? 5 Things to Know
Making Your Money Last

Considering Early Retirement? 5 Things to Know

Before you accept a buyout, do the math to see if you really can afford to retire. (We'll show you how.) Then follow up with these tried-and-true stra…
October 15, 2020
9 Tips for Better Time Management in Retirement

9 Tips for Better Time Management in Retirement

These important time management techniques will help destress your life as you get busier -- yes, busier -- in your golden years.
October 14, 2020