A main argument in investing is between the effectiveness of active portfolio management versus passive management. Using an actively managed portfolio, a manager tries to outperform a given benchmark index by using their judgment in selecting individual securities and making their own decisions on when to buy and sell them. A passively managed portfolio attempts to mimic the benchmark performance, and in the process, minimize expenses that can reduce an investor's net return.

Each management system has strong advocates who argue that the effectiveness of its strategy outperform those of the opposite management system.


Proponents of active portfolio management believe that a proficient investment manager can outperform a benchmark index's returns. Conversely, the advocates of passive investing insist that it is more effective to use low-cost index-based investments.


Active Investing: Focused on Added Value

Proponents of active portfolio management believe that by choosing the best investments, taking advantage of trends in the market, and attempting to manage associated financial risks, a proficient investment manager can generate returns that outperform a benchmark index. As an example, an active manager whose benchmark is the Standard & Poor's 500 Index (S&P 500) might attempt to beat market returns by weighting certain industries or individual securities very highly, allocating more assets to those specific sectors than the index does. Or they may try to mitigate a portfolio's overall risk by temporarily increasing the percentage allocated to more conservative investments, such as using cash alternatives.

Using an actively managed individual portfolio also allows the manager to take into account certain tax considerations. As an example, a separate account can harvest capital losses to offset any capital gains realized by its owner, or a sale can be timed in order to minimize any capital gains. Actively managed mutual funds have the ability to do the same on behalf of its shareholders.

In contrast, an actively managed mutual fund's investment may constrain the flexibility for the manager. As an example, a fund may be required to maintain a certain percentage of its assets in a certain security type. A fund's prospectus will outline any such provisions, and it is highly recommended that you read it before investing any assets.

Passive Investing: Shifting the Focus to Costs

Advocates of passive investing (typically referred simply as indexing) believe that the most effective way to capitalize on market returns is to use low-cost market-tracking index investments. Using this strategy is based off the concept of the efficient market, which states that due to all investors having access to all company information and securities, it's virtually impossible to gain an advantage over other investors. As new information becomes available, market prices respond with adjustments to reflect the security's true value. It's said that market efficiency, means reducing investment costs is the key to improving net returns.

Indexing does create certain cost efficiency; due to the investment simply reflecting an index, no research is required for securities selection. Additionally, trading is relatively infrequent (typically bought or sold only when the index changes), thus trading costs are often lower in comparison. Also, infrequent trading typically generates fewer capital gains distributions, which means tax efficiency can be relative.

Disclaimer: Before investing in an active OR passive fund, the investment, associated risks, charges, and expenses all should be carefully considered. All of which may be found located in the prospectus available from the fund. It is recommended that the investor should read through the prospectus carefully before investing.

Utilizing Asset Allocation to Blend Passive & Active Investing

All forms of investing involve risk of losses and there is no guarantee that any investing strategy will be successful.

The core-satellite approach represents a way to utilize both investment strategies. It is basically an asset allocation model that seeks to resolve the differences between passive versus active portfolio management. Instead of using only one of the investment approaches, the core-satellite approach utilizes both. The core of your investment assets are kept in cost-efficient passive investments which generates returns by tracking a specific benchmark. The balancing of the portfolio is then invested in a series of satellite actively managed investments, which have the potential to boost returns while also mitigating the overall associated risk of the portfolio.

Disclaimer: No investment strategy can guarantee a profit or full protection against losses.

Controlling Costs of Investment

Breaking your portfolio down in portions rather than focusing a majority of your portfolio to actively managed investments can allow you to minimize investment costs that may reduce returns.

As an example, consider the hypothetical $500,000 portfolio which is 100% invested in actively managed with an average expense level of 1.5%, which results in annual expenses of $7,500. If 70% of the portfolio were invested instead in a low-cost index fund (ETF) using an average expense of 0.25%, annual expenses on the same portion of the portfolio would cost $875 per year. If a series of satellite investments with expense ratios of 2% were used for the remaining 30% of the portfolio, annual expenses for the satellites would be $3,000. Total annual fees for core and satellites together would equal $3,875, thus creating a savings of $3,625 each year. If this amount were to be reinvested into the portfolio, that amount may also increase its potential long-term growth adding an even greater return.

Disclaimer: This hypothetical scenario is intended only as an illustration of the math involved rather than the results of any specific investment.

Commonly used core investments track benchmarks such as the S&P 500, the Russell 2000® Index, the NASDAQ 100, or various international and bond indices. Other commonly used core investments may instead track specific style or market-capitalization benchmarks in order to provide a comparison between value and growth bias or a market capitalization tilt.

Core holdings are generally chosen for their low-cost ability to closely track a specific benchmark. On the other hand, satellites are generally chosen for their additional value potential, which may be done through enhancing returns or reducing associated risk in a portfolio. Ideally, satellite investments include less efficient asset classes where the potential for added value from active management is increased. This is particularly true with asset classes where returns are not closely correlated with the core or other satellite investments. Due to it not being uncommon for satellite investments to be volatile compared to core investments, it is always important to view them within context of the entire portfolio.

Asset Allocation: Tactical vs. Strategic

The main concept of applying the core-and-satellite approach to investments is similar to practicing both tactical and strategic asset allocation.

A portfolio with allocations heavily in companies of one particular industry or market sector may not be sufficiently diversified which could subject the portfolio to a significant level of volatility and risks.

Strategic asset allocation is basically a long-term investment approach. This is due to it taking into account your financial goals, time horizon, risk tolerance, and historic returns for many asset classes in determining just how your portfolio should be allocated diversely among multiple asset classes. That allocation may shift gradually as your financial goals or situation, and time changes. You may choose to refine it from time to time; however, periodic re-balancing tends to keep it relatively stable in the short term.

In contrast, tactical asset allocation tends to be seen as more opportunistic. The tactical approach takes advantage of shifting market conditions by increasing the level of investment in asset classes that are expected to have a higher performance in the shorter term, or in those the manager believes will reduce risk. Tactical asset allocation tends to be the most responsive to immediate market adjustments and anticipated trends.

While strategic or tactical asset allocations can be used within an entire portfolio, some money managers like to establish a strategic allocation for the bulk of a portfolio, and practice tactical asset allocation with a smaller portion of the portfolio.

Disclaimer: Asset allocation and diversification are simply methods used to help manage investment risk and do not guarantee a profit or protection against associated risks in an investment.

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