There are two basic approaches to investment management:

  • Active asset management is based on a belief that a specific style of management or analysis can produce returns that beat the market. It seeks to take advantage of inefficiencies in the market and is typically accompanied by higher than average costs (for analysts and managers who must spend time to seek out these inefficiencies).

  • Passive asset management is based on the concept that markets are efficient, that market returns cannot be surpassed regularly over time, and that low cost investments held for the long-term will provide the best returns.

For those who favor an active management approach, stock selection is typically based on one of two styles:

  • Top-down - managers who use this approach start by looking at the market as a whole, then determine which industries and sectors are likely to do well given the current economic cycle. Once these choices are made, they then select specific stocks based on which companies are likely to do best within a particular industry.

  • Bottom-up - this approach ignores market conditions and expected trends. Instead, companies are evaluated based on the strength of their financial statements, product pipeline, or some other criteria. The idea is that strong companies are likely to do well no matter what market or economic conditions prevail.

Passive management concepts to know include:

  • Efficient market theory - this theory is based on the idea that information that impacts the markets (such as changes to company management, Fed interest rate announcements, etc.) is instantly available and processed by all investors. As a result, this information is always taken into account in market prices. Those who believe in this theory believe that there is no way to consistently beat market averages.

  • Indexing - one way to take advantage of the efficient market theory is to use index funds (or create a portfolio that mimics a particular index). Since index funds tend to have lower than average transaction costs and expense ratios, they can provide an edge over actively managed funds which tend to have higher costs.


Suitability Factors

Related Articles
  1. Investing

    Active or Passive Investing? What's Best for You

    Be strategic about which of these investing strategies you follow (and when).
  2. Investing

    A Statistical Look at Passive Vs. Active Management

    Find out what the data has to say about the passive management Vs. active management debate, and why there isn't necessarily a clear winner.
  3. Retirement

    Is Passive Investing Effective for Retirement Savings?

    Learn about the differences between active and passive investing for those approaching retirement. Discover how passive investing is gaining popularity.
  4. Investing

    4 Reasons Most ETFs are Passively Managed

    Find out the top four reasons most ETFs are passively managed, including the benefits of lower costs, greater tax efficiency and low asset turnover.
  5. Investing

    Why Your Passive Fund Is Crushing Active Managers

    A new study shows passive funds outperformed over 5, 10 and 15 years
  6. Investing

    The Lowdown On Index Funds

    If you can't beat the market, why not join it? Read on to go over your options.
  7. Financial Advisor

    Are You a Bottom-Up or Top-Down Investor?

    Both of these approaches are used to pick stocks. Here's a look at how they work.
  8. Retirement

    Active vs. Passive Investing for Retirees

    For most investors, sticking with a passive strategy for retirement investing will probably result in the best long-term returns. But not always.
  9. Investing

    The 4 Key Elements Of A Well-Managed Portfolio

    If you choose an actively managed portfolio, be sure that your manager isn't neglecting one of these four points.
Frequently Asked Questions
  1. What Factors Cause Shifts in Aggregate Demand?

    Find out how aggregate demand is calculated in macroeconomic models. See what kinds of factors can cause the aggregate demand ...
  2. Who are Whole Foods' (WFM) main competitors?

    Learn more about Whole Foods Markets, who insists its products are sustainable. Thanks to the competition, however, its marketing ...
  3. What are the Differences Between Ex Works (EXW) and Free On Board (FOB)?

    Learn about Ex Works and Free on Board, the main difference between these Incoterms, and the responsibilities of buyers and ...
  4. What are Common Examples of Monopolistic Markets?

    Discover what causes real instances of market monopoly, how it persists and where monopoly privilege is most common in the ...
Trading Center