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Passive Investment Management

Passive investing sounds like nothing is going on. You are sitting around waiting for something to happen. But, passive has a different definition on Wall Street and you need to know this type of investment management service exists.

  • It is your alternative to active money management
  • It is a lower risk, lower cost alternative for investment management
  • You are less dependent on the quality of investment advice
  • 90% of Wall Street advisors do not recommend passive strategies
  • Wall Street makes less money from passive strategies 

Sales Pitch

Advisors who sell passive investment strategies also have a sales pitch. They say most of your performance comes from your asset allocation decision. It is more important to be invested in the stock market than it is to own particular stocks. That's because the same economic events cause stocks to move up and down together .  

Why don't more investors use this strategy? Very persuasive salesmen convince them they can produce superior results. Investors do not question this undocumented sales claim because they believe the salesmen are ethical investment experts.

No Crystal Ball

The foundation for passive investment strategies is the belief that Wall Street advisors and money managers do not have crystal balls that accurately predict the future performance of the securities markets. Pro-passive pundits believe active management does not work for the following reasons:

  • Managers cannot predict future events
  • Managers tend to win in short spurts
  • High expenses offset any improvements in performance
  • Riskier strategies produce bigger losses in down markets

Asset Class Investing

You can divide the market into as many asset classes as you want to. At the top are stocks, bonds, and money market investments. There are numerous asset classes within each primary category. For example, stock asset classes include:

  • Small capitalization stocks
  • Large capitalization stocks
  • Stocks of U.S. companies
  • Stocks of foreign companies
  • Stocks in emerging markets

What is the best way to capture the performance of multiple asset classes?

Diversification

Why invest in multiple asset classes? There are two reasons that are based on your inability to predict future results:

  • You are right: One of more investments produce big returns
  • You are wrong: You have reduced your risk of large investment losses

Index Funds

You want to capture the performance of large capitalization U.S. stocks. You decide to use a passively managed index fund to capture the results. You select an index fund that duplicates the performance of the S&P 500 (500 large capitalization U.S. stocks). You do not conduct research to determine which stocks you buy. You buy the index fund and you are automatically invested in 500 stocks.

Buy & Hold

Passive may come from this investment process. You invest in multiple index funds. You do not change your allocations between funds. You do not buy and sell funds. You are passive because you do not believe change adds value. You keep the same allocation and investments for several years. You ignore current market conditions.

Investment Risk

Let's assume a passive investment strategy has a risk rating of 1.0. An active investment strategy has a risk rating of 1.5. It is 50% riskier than the passive strategy. You can reduce investment risk by selecting a passive strategy.

Investment Expenses

Active managers have expensive analysts and portfolio managers. Passive managers do not. Index funds can be run by computers. You can reduce your asset management expense by selecting a passive investment strategy.

Paladin says.....

It is important you know these choices exist. That's because your Wall Street advisor may not present these options to you. He may recommend active management because he and his firm make more money. Some advisors recommend both. Index funds for efficently priced asset classes and active managerment for less less efficiently priced asset classes. It's your money!

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