Investment wealth must be managed to be most effective. However, an eclectic collection of bank CDs, mutual fund accounts, annuity contracts, IRAs and stale 401(k) accounts is commonly how busy people “manage” their investments. Such an uncoordinated money management approach can lead to financial shortfalls down the road.
There are three main categories of money management – active, passive and a combination of the two often referred to as core-satellite.
Active money management assumes that investment professionals can effectively “beat the market” over time by managing a security portfolio to outperform a market benchmark or an investment peer group. For example, the objective of an actively managed mutual fund manager that specializes in large company stocks is to outperform the investment return of the S&P500 Index after fees. An actively managed investment should be compared to a market benchmark and a peer group to properly measure its true risk-adjusted performance. Active management tends to perform better in down markets because the manager can invest more defensively – hold cash in the portfolio for example - than an index fund can.
A Passive money management approach assumes that investment markets are efficient and thus difficult for active managers to outperform over time. Index funds and exchange traded funds (“ETFs”) are two popular examples of low-cost, passive management investment instruments. Large U.S. stocks and U.S. Government bonds are two asset classes especially well-suited for passive investing since they are widely analyzed segments and are difficult for active managers to find investment value that others don’t see.
The core-satellite approach combines qualities of both passive and active management to seek risk-adjusted superior investment returns with lower costs.
