There are plenty of buzzwords in the investing world, few of them more debated than the idea of active vs. passive investing.
Passive doesn’t not necessarily mean “do nothing.” After all, doing nothing would mean not investing at all!
Rather, we advocate for a thoughtfully structured portfolio process. Our mantra at Rebalance is “portfolio indexing,” the ultimate goal of market-like returns with lower overall risk.
The first thing to understand about portfolio indexing is the basic idea of the index fund. Then, layer in the idea of “risk-adjusted” return.
Those two ideas, taken together, make the whole passive vs. active debate easier to understand.
Why index funds?
An index fund is a fund that owns many different stocks or bonds. Holdings can number into the hundreds and even thousands.
Index funds give the investor a chance to own many companies at a low cost. The underlying idea is that if the entire index goes up, say, the S&P 500 Index of large U.S. stocks, so does the value of your investment.
That’s different from an “active” stock fund, where a manager tries to choose a smaller number of stocks — perhaps as few as 10 or 20 — that he believes will perform better than the broad stock market, i.e., the index itself.
Indexing wins because research shows that active fund managers are wrong most of the time. Those who do “beat” the index typically give back those gains in the next year or two. Active managers also charge much higher fees compared to index funds.
Now let’s add in the second idea — risk.
We know that stocks go up and down in value over time. That’s normal and nothing to worry about if your investment goal, say, retirement, is decades away.
However, some investors have short-term goals. Maybe they will retire in five years, or the money they have invested is for a child’s college tuition.
At Rebalance, we talk with clients one-on-one. We learn about their dreams and how they expect to finance their goals, both long- and short-term.
The risk we adjust for is not the risk of a market decline. That kind of risk is already well understood.
Rather, the risk is that the investor will react poorly to the occasional market decline and make an emotional decision to sell, locking in losses permanently.
For us, the “active” part is collaborating with you to choose your personal best path forward. By smoothing out returns over time, a risk-adjusted portfolio of index funds can provide solid, repeatable gains with fewer jolts along the way.
Adjusting the portfolio to match your expectations allows us to provide the highest-quality performance while insulating you from unwelcome surprises.
Costs matter
Passive investing is a misnomer. There is nothing passive about researching index products, constructing risk-adjusted portfolios, and working individually with our clients day-to-day.
Our Investment Committee, which includes Princeton professor Burt Malkiel, former Yale endowment chairman Charley Ellis, and former IBM Retirement Funds chief Jay Vivian, is very active in the pursuit of the best possible portfolios for Rebalance clients.
They can and do change the underlying building blocks of those portfolios.
But we also stick very closely to the fundamental idea of owning the market, not picking stocks, and doing so at the lowest possible cost for our clients.
As the late John Bogle, the celebrated founder of Vanguard Group, put it: “In investing, you get what you don’t pay for. Costs matter.”
“So intelligent investors will use low-cost index funds to build a diversified portfolio of stocks and bonds, and they will stay the course. And they won’t be foolish enough to think that they can consistently outsmart the market.”
We could not have put it any better.
