Portfolio Management - Active vs. Passive Portfolio Styles


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. FA

    The Basics of The Series 79 Exam

    Passing the Series 79 exam is usually necessary for anyone who wants to work in investment banking.
  2. Term

    What is the Series 66?

    The Series 66 exam is one of two tests required to register as both a securities agent and an investment advisor.
  3. Professionals

    Breaking Down Financial Securities Licenses

    Find out which exam you need to begin your career as an investment professional.
  4. Professionals

    Career Advice: Financial Analyst Vs. Investment Banker

    Read an in-depth comparison about working as a Financial Analyst vs. working as an Investment Banker, two highly prestigious business careers.
  5. Professionals

    Who Needs to Take the Series 65?

    Most states require individuals to pass the Series 65 exam in order to act as investment advisors.
  6. Personal Finance

    RIAs and Brokers: What's the Difference?

    RIAs and brokers are held to different standards when providing investment advice. Here's how they differ.
  7. Investing Basics

    Brokers and RIAs: One and the Same?

    Brokers and registered investment advisors have some key differences. Here's what you need to know.
  8. Professionals

    Understanding Series 6

    Upon successful completion of the Series 6, an individual will have the qualifications needed to sell open end mutual funds and variable annuities
  9. Professionals

    Top Strategies on How to Become a Stock Broker

    Gunning to be a stock broker and want an edge? Here's some veteran advice.
  10. Trading Systems & Software

    Steps to Starting Up an Independent Broker Dealer

    Launching your own broker-dealer is a lot of work, but the potential payoff is great, both personally and financially.
RELATED TERMS
  1. Series 6

    A securities license entitling the holder to register as a limited ...
  2. Series 79

    A examination to ensure a candidate is qualified to become a ...
  3. Research Analyst

    A person who prepares investigative reports on equity securities. ...
  4. Series 34

    An exam required for individuals seeking to engage in off-exchange ...
  5. Financial Advisor

    One who provides financial advice or guidance to customers for ...
  6. Series 28

    An exam given by the Financial Industry Regulatory Authority ...
RELATED FAQS
  1. Is a financial advisor required to have a degree?

    Financial advisors are not required to have university degrees. However, they are required to pass certain exams administered ... Read Full Answer >>
  2. Do financial advisors have to be licensed?

    Financial advisors must possess various securities licenses in order to sell investment products. The specific products an ... Read Full Answer >>
  3. If I have only a limited amount of time to study for the Series 6, what should I ...

    The Series 6 Investment Company and Variable Contracts Products Representative Qualification Examination is administered ... Read Full Answer >>
  4. What role does the 'chip cycle' play in the electronics sector?

    There are several highly acclaimed private Series 6 Exam courses in the United States. Many can be completed online. Popular ... Read Full Answer >>
  5. What does passing the Series 6 enable me to do?

    The Series 6, or the Investment Company Products/Variable Contracts Limited Representative, exam is administered by the Financial ... Read Full Answer >>
  6. What are the differences between the Series 6 exam and the Series 7 exam?

    The Financial Industry Regulatory Authority (FINRA) offers a variety of licenses that must be obtained before conducting ... Read Full Answer >>
Hot Definitions
  1. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  2. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  3. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  4. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
  5. Dark Pool Liquidity

    The trading volume created by institutional orders that are unavailable to the public. The bulk of dark pool liquidity is ...
Trading Center