Active investing produces frequent changes in your portfolio. The changes are based on current market conditions or your advisor's outlook for future market conditions. For example, your advisor believes the stock market is going up so he moves money from bonds to stocks. He thinks technology stocks will outperform retail stocks so he sells retail and buys technology. Or, he thinks IBM is a better buy than HP so he sells HP and buys IBM. This is active portfolio management.
Most Wall Street advisors sell active management because it delivers superior investment returns. This is a sales pitch when there is no proof that their recommendations or services actually produce better returns.
What if a car salesman tried to sell you a $20,000 automobile that gets 80 miles to the gallon? It sounds to good to be true. However, you do not get to see or test drive the car and there are no independent reports that validate his claims. Your natural skepticism would cause you to reject the sales pitch.
But, what if all car salesmen sold the same product and used the same sales tactics? More than likely you would buy from the salesman who had the most convincing sales pitch. Welcome to Wall Street!
The Self-Proclaimed Expert
You need a financial expert to make active investing work. By selling active management the advisor is establishing himself as a financial expert without providing any proof he is a real expert. He says he can deliver superior performance with active management. You believe him so you buy what he is selling.
What if he is not an expert? What if the advisor sells active management because he makes more money. For example, the sale of an actively managed mutual fund pays a big commission (5% of your assets). The sale of a passively managed index fund does not pay a big commission, in fact it may not pay any commissions.
Money managers, who use active management principles, can produce superior performance for short time periods. For example, they produce great results when their strategies are favored by the market. But, the market is cyclical and their strategies eventually go out of favor. Active money managers continue to execute the same styles even when their styles are out of favor. Why? They were hired to execute a specific investment management strategy.
Advisors claim superior results, but prospectuses and service agreements tell a different story. They contain multiple disclaimers that contradict the sales pitches. For example, a disclaimer says past performance is not a reliable indicator of future performance. In fact, it may be just the opposite. The highest performers in the past may be the lowest performers in the future.
Risk goes up when your goal is superior returns that are produced by your Wall Street advisor's active management recommendations. For example, your advisor tells you:
- The stock market is going up, but it goes down
- The stock market has bottomed, but it continues to decline
- The recovery will be lead by technology stocks, but it is lead by energy stocks
There are no free lunches on Wall Street. You want superior performance? You have to accept increased risk that is caused by bad advice, bad decisions, bad timing, bad markets, or all of the above.
Wall Street advisors may sell superior performance to justify the higher expenses of active management. For example, a 2% fee does not sound excessive if Wall Street advisors convince you they can produce 20% returns. You may not get the 20% performance, but you will pay the 2% fee. Substantial commissions may also be deducted from your assets.
You need a real investment expert if you want a chance at earning above market returns. This expert will diversify your assets among multiple, active money managers so part of your assets are producing superior returns during most market conditions.