[Video] Active, Passive and Self-Management | The Cornerstone Take

Finance | Provided by Cornerstone Advisors

By just about any metric, American stock markets are on a historic run that began in 2009 and continues nearly a decade later. Over these 9 years, the Dow Jones Industrial Average quadrupled in value. Over the same time frame the NASDAQ 100 is up 425% and the S&P500 is up almost 300%. It’s now one of the longest and strongest bull market runs since World War II.

The old adage, “a rising tide lifts all the boats” certainly seems to apply to this bull market. Most portfolios have seen a steady and significant increase in value. While this is great news for investors, the bull market has had the unintended consequence of igniting one of the most hotly debated topics in finance: active vs passive portfolio management.

We’re going to start with a few definitions, look at some of the pros and cons of each school of thought, and then share with you our Cornerstone philosophy.

 

Self-Management

Self-management isn’t typically included in the debate but we thought it would be helpful to include it in our discussion. Self-management is exactly how it sounds: an individual overseeing their own wealth. Typically, that’s a common approach for an individual who has focused their attention and energy on their career. It’s likely they have not yet generated a significant amount of wealth or may be still working towards a liquidity event such as taking a company public or selling their company.

Of course, after those who self-mange experience a sudden accumulation of wealth, things change. The stakes are raised, and it makes sense to reassess how their wealth is being managed. Often, these individuals seek out Cornerstone’s expertise, usually by referral from existing clients or one of their trusted professional advisors.

Advantages of Self-Management

  • Fees: There are less fees when there’s no professional wealth manager involved.
  • Control: The individual is in full control of their portfolio at all times (for better or worse).

Possible Shortcomings of Self-Management

  • Tax/Estate: The complexity of today’s tax and estate planning laws cannot be overstated. Honest and easily-avoidable mistakes can have a significant negative impact on wealth.
  • Attention: Aggregating, analyzing and synthesizing the vast amount of information that will impact their investment portfolio is all but impossible for an individual with responsibilities outside of wealth management.
  • Emotion: It can be easy to feel confident when markets are rising and things are going well. But when the inevitable market correction happens and/or unexpected challenges arise (think real estate financial crisis of 2008-10), individuals who are emotionally invested in their wealth can panic and make short sighted decisions.

 

Passive Management

Passive management is the creation of a portfolio intended to track the returns of a select market or benchmark as closely as possible. It’s a “set it and forget it” kind of investing. The passive management strategy avoids the picking of individual stocks or bonds with the assumption that it’s difficult to beat the market. Instead of trying to beat the market, the investor owns the market. Many people first get exposed to passive management through their retirement or 401K plan that invests in index mutual funds.

Advantages of Passive Management

  • Time: Passive management is ideal for people who don’t have the time or energy to research and investigate individual investments or advisors. The passive investment vehicles are managed by professionals and trusted entities such as Fidelity or Vanguard.
  • Fees: Passive management typically has lower fees associated with it because a large number of investors are all making the exact same investment. Costs are reduced due to an efficient and systematic approach without consideration of individual investor customization or preference
  • Diversification: By the nature of owning many stocks or bonds, passive investing offers a level of natural diversification.
  • Emotion: Because passive investing puts some emotional distance between the investor and their money, it can be easier to weather the ups and downs in the markets. Interestingly, this is one of the few advantages that both active and passive management share.
  • Automation: The increasing sophistication of “robo” style investment programs offer efficiency. While they are still in their relative infancy, in many ways they are more dispassionate than even the best human advisor. They are able to react to variables and changes rapidly.


Possible Shortcomings of Passive Management

  • Risk: One thing that’s true about passive investing is that it also means passive risk management. The longer any market expands, the higher risks can become. For folks who have the stomach for it, who can ride through the corrective side of that market, that’s fine. It’s just important to understand that with passive investing comes passive risk control.
  • Limits: Passive investments will never beat the market because they are the market. This will always be a natural limiter on overall return.

 

Active Management

Where passive investing settles for accepting the returns of the markets as a whole (less fees), active management tries to beat the market by actively buying and selling individual investments and/or shifting resources across different asset classes. Instead of buying an index like the NASDAQ 100, active managers make specific, targeted purchases across a variety of investment classes. Active managers use research, forecasting, informed judgment and experience in deciding on what securities to buy, hold and sell.

Advantages of Active Management

  • Risk: Active fund managers can manage risk more proficiently because they are not tied to a specific market or benchmark.
  • Diversification: Because they are not required to own the market, they can access a broader range of investments in varying proportions based on their assessment of risk and reward.
  • Agility: Active management offers the flexibility to adapt to changing market conditions.
  • Emotion: Active investing puts emotional distance between the investor and their money, leveraging the management of an expert advisor, making it a bit easier to weather the ups and downs in the markets.


Possible Shortcomings of Active Management

  • Fees: Due to the time and labor of research that is involved with active management, the fees can be higher than passive management.
  • Ups / Downs: With the ability to outperform the market comes the reciprocal ability to underperform the market.

 

Cornerstone Take

It’s not hard to see why there is so much debate around active versus passive. Debate is good because it brings new ideas to the forefront and enables one to consider alternate schools of thought. At the same time, we don’t want to lose sight of what we’re trying to accomplish for our clients in pursuit of their financial and life goals.

It’s important to understand there is more than one way to attain ‘success’ and there are multiple ways to reach your goals. The typical Cornerstone client is a high achiever. They have strong opinions and understand what it takes to succeed. It stands to reason that they might want to be involved with how their wealth is managed.

We know that each client has their own perspectives when it comes to investing. Therefore, we offer multiple investment vehicles including active managers, passive indexes, investments in real estate and private equity, and custom portfolios for tax efficiency.  With this approach we can design and implement a portfolio that meets our client’s personal desires, expectations and preferences. With access to multiple investment vehicles, we are able to effectively address our client’s primary objectives of enhancing returns, managing risk, minimizing costs and limiting taxes. While Cornerstone was founded on an active philosophy, we understand that there is seldom a one-size-fits-all approach for clients.

Individual investors who seek simplicity and the lowest fees may prefer the minimal expense associated with passive style investments. They achieve a sense of security knowing that their wealth is being handled in the same way as so many other investors. Other investors might not be comfortable buying the whole market at today’s prices and will seek expert assistance to avoid the most overvalued investments.  While still others will want to carve out a portion of their portfolio to pursue individual stocks, certain sectors of the market or even cause-driven investing that’s close to their heart.

We have the tools, the skill-set and the maturity to have the conversation with a client to structure their portfolio in a way that builds confidence and provides comfort, allowing them to stick with a program and be successful over the long term. This might take the form of financial coaching, exploring opportunities and ideas, or showing them paths they might not have considered. It’s all about the application of our unique resources to the client’s unique wishes.

 

Conclusion

Generally, people tend to think active vs passive is an either/or concept. That’s simply not the case. When asked in meetings with clients and people new to Cornerstone, “Is Cornerstone active or passive?” Our answer is always “yes.” When it comes to active vs passive, it need not be an either/or type of answer. Whether they prefer active or passive management, both are clients that will feel at home with Cornerstone. Active and passive can exist in the same conversation, in the same firm and in the same portfolio. It’s just a matter of finding what’s right for each individual client.



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