There are two basic approaches to investment management:

  1. Active asset management is based on a belief that a specific style of management or analysis can produce returns that beat the market.

    • The active approach 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).

    • Market timing is an extreme example of active asset management. It is based on the belief that it's possible to anticipate the movement of markets based on factors such as economic conditions, interest rate trends or technical indicators. Many investors, particularly academics, believe it is impossible to correctly time the market on a consistent basis.

  2. Passive asset management is based on the belief that:
    • Markets are efficient.
    • Market returns cannot be surpassed regularly over time.
    • Low-cost investments held for the long-term will provide the best returns.

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

  • The active approach 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).

  • Market timing is an extreme example of active asset management. It is based on the belief that it's possible to anticipate the movement of markets based on factors such as economic conditions, interest rate trends or technical indicators. Many investors, particularly academics, believe it is impossible to correctly time the market on a consistent basis.

Within the tutorial Guide to Stock-Picking Strategies we explore the art of stock picking, with the aim of achieving a rate of return that is greater than the market's overall average.

Passive management concepts to know include:

  • Markets are efficient.
  • Market returns cannot be surpassed regularly over time.
  • Low-cost investments held for the long-term will provide the best returns.


Within the tutorial Index Investing, we discuss some of the major stock indexes and explain how one can invest in the stock market through index funds:

When choosing index funds, it's important to realize that not all index funds are created equal. Read more on this topic within the article You Can't Judge an Index Fund by It's Cover.

Consider these sample exam questions:

  1. The efficient market theory states that:
    1. Future market prices are determined by the discounted value of future dividends.
    2. Technical analysis tools cannot be used to beat the market, since current prices already reflect all available information about previous price patterns.
    3. Current market prices already reflect all available information.
    4. Market prices are determined by supply and demand.

The correct answer is "c"; "b" is incorrect, since the efficient market theory is not concerned with technical analysis.


  1. Passive asset management involves:
    1. Using index funds as the investments for each asset class
    2. Choosing the stocks or mutual funds to be purchased for each asset class
    3. Buying securities for each asset class and holding them until the funds are needed
    4. Buying securities for each asset class and selling them when they reach their price targets

The correct answer is "a" - while index funds are not a requirement of passive management, they are a frequently used tool. "c" is incorrect because passive management does not preclude making portfolio changes. For example, periodic rebalancing is performed, and changes can be made in response to changes in the client's risk tolerance, financial situation, goals and so forth.



Introduction

Related Articles
  1. Investing

    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.
  2. 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.
  3. Investing

    The Lowdown On Index Funds

    If you can't beat the market, why not join it? Read on to go over your options.
  4. 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.
  5. 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.
  6. Managing Wealth

    Active or Passive? How to Blend Aspects of Both

    Investment fund strategies can broadly be divided into either active management or passive management.
  7. Retirement

    Active vs. Passive Investing During Retirement

    How these two investing approaches work – and how to decide which best suits your precious nest egg.
  8. Investing

    Active Management Case Study: Comparing Index to Actively Managed Fees (MORN)

    Find out how actively managed funds compare with passively managed funds in terms of cost and whether higher cost funds outperform lower cost funds.
  9. 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.
Trading Center