Evaluation of Customers - Portfolio Styles - Active vs. Passive

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. Professionals

    Portfolio Styles: Active vs. Passive

    FINRA/NASAA Series 66: Section 6 Portfolio Styles: Active vs. Passive. This section discusses two different portfolio management styles: active and passive.
  2. Professionals

    Active vs. Passive Portfolio Styles

    NASAA Series 65: Section 12 Active vs. Passive Portfolio Styles. In this section portfolio management compares actively managed and passively managed portfolios. Top up, bottom down, efficient ...
  3. Mutual Funds & ETFs

    Exchange-Traded Funds: Active Vs. Passive Investing

    Although indexing (a passive investment strategy) has been used by institutional investors for many years, it is still relatively new for the typical individual investor. Because ETFs use predominately ...
  4. Mutual Funds & ETFs

    Passively Managed Vs. Actively Managed Mutual Funds: Which is Better?

    Learn about the differences between actively and passively managed mutual funds, and for which types of investors each management style is best suited.
  5. 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.
  6. Investing Basics

    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.
  7. Mutual Funds & ETFs

    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.
  8. Options & Futures

    The Lowdown On Index Funds

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

    Active vs. Passive Investing During Retirement

    How these two investing approaches work – and how to decide which best suits your precious nest egg.
  10. Trading Strategies

    Active or Passive? How to Blend Aspects of Both

    Investment fund strategies can broadly be divided into either active management or passive management.
RELATED TERMS
  1. Passive Management

    A style of management associated with mutual and exchange-traded ...
  2. Active Management

    The use of a human element, such as a single manager, co-managers ...
  3. Index Investing

    A form of passive investing that aims to generate the same rate ...
  4. Portfolio Management

    Portfolio Management is the art and science of making decisions ...
  5. Active Risk

    A type of risk that a fund or managed portfolio creates as it ...
  6. Actively Managed ETF

    An exchange-traded fund that has a manager or team making decisions ...
RELATED FAQS
  1. What is the difference between passive and active portfolio management?

    Understand the difference between active portfolio management and passive portfolio management, and how each strategy benefits ... Read Answer >>
  2. What is the difference between passive and active asset management? (SPY)

    Find out about active asset management, passive asset management, how these strategies are utilized and the differences between ... Read Answer >>
  3. Are target-date funds (TDFs) actively managed?

    Learn how target date funds (TDFs) can be actively managed or go with a more of a hands-off approach featuring passively ... Read Answer >>
  4. What are the differences between weak, strong and semi-strong versions of the Efficient ...

    Discover how the efficient market theory is broken down into three versions, the hallmarks of each and the anomalies that ... Read Answer >>
  5. Why do index funds tend to have low expense ratios?

    Understand what an index fund is and why the nature of index funds causes them to have lower expense ratios than more actively ... Read Answer >>
  6. What are the disadvantages of an index fund over an actively managed fund?

    Read the advantages an actively managed fund has over its more staid compatriot, the indexed fund, and make your own decision ... Read Answer >>
Hot Definitions
  1. Return On Invested Capital - ROIC

    A calculation used to assess a company's efficiency at allocating the capital under its control to profitable investments. ...
  2. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  3. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  4. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  5. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  6. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
Trading Center