I’m writing this on June 20th, 2022. We’re coming off one of the greatest bull market runs of all time, and entering a potentially new era of investing.
As you try and successfully navigate your financial future, and work on solving the ever-present money problem, I wanted to make the case for active portfolio management.
I entered the professional world and started my career in personal finance in August of 2001, just before 9/11. That catastrophic event ushered in what would go on to be 20 years of historically low interest rates (if you’d like to research actual rates, the St. Louis Fed has great tools).
While there were many factors that led to the stock market boom, the low interest rate environment played an important role. With rates in the low single digits, there was little to no incentive to put your money in fixed income investments. The stock market became the only game in town.
As we look into our crystal balls, what will be different over the next 10 to 20 years? Increasing interest rates will once again make fixed income investing attractive. As metals become more necessary, their value will go up and investments will no doubt move in that direction. Crypto assets like Bitcoin and NFTs will also attract additional investment.
What will increased competition mean for the stock market? We’ll have to wait and see. It’s my goal to help you look at your investing differently, and to explore all available options.
Here’s what we’ll cover:
- Active versus passive investment management
- Understanding asset classes
- Bringing it all together
Let’s get started.
Active versus passive investment management
When the market goes up for extended periods of time, it make investing fun and easy. When this is the case, it makes sense to by low-cost investments that get the same returns as the broader market. Why do anything else?
This is essentially what passive investment management is all about. Buy a low-cost index fund and get the same performance the market gets.
What about active investment management? Active investing attempts to “beat” or get a better return than the broader market. An active manager looks for opportunities to captilize on, and to invest in “value,” meaning high-quality investments that are currently underpriced.
And that’s one of the key differences between these two approaches. Passive investment managers believe the Efficient Market Hypothesis to be correct. That hypothesis suggests that all publicly known information is currently reflected in the price of an investment. Therefore, there isn’t an opportunity for value investing.
Active investment management does not subscribe to the Efficient Market Hypothesis. It believes there is always opportunity to outperform the stock market. Also, active managers argue, their approach provides greater downside risk; when the market goes down, they won’t lose as much money as a passive investment manager.
Bottom line: is it possible to beat the markets? Yes, people do it every year. But it’s kind of like playing in the NFL. It’s possible for anyone to do it, but very few humans ever actually do it.
So, is it possible for you to beat the market? Maybe. Doing so would require you to commit to learning how to do it.
I’ve always been curious why we talk about “investing” as the stock market, when there are so many other ways to invest. A conversation on asset classes is warranted.
Understanding asset classes
Asset classes are groups of similar investments that are governed by the same laws and standards. Here are the traditional asset classes:
- Domestic equity: These are the stocks of publicly traded companies located inside the United States.
- International equity: These are the stocks of publicly traded companies located outside of the United States.
- Fixed income: These are securities that pay a fixed interest rates or income to investors. Examples are government securities, bonds and CDs.
While these are the traditional asset classes, there are four additional areas to take into consideration:
- Real assets: Examples are commodities, global natural resources and Real estate investment trusts.
- Absolute return: This is an investment approach that seeks a stated investment return without being constrained to specific strategies.
- Private equity: Examples are listed private equity investments, leveraged buyouts and venture capital.
- Crypto assets: Examples are crypto currencies and NFTs.
Inside your 401(k) or IRA, what are you invested in? Commonly, it’s the traditional three asset classes. What about your brokerage account, 529 plan and other accounts? All too often, we’re only investing in traditional stock market investments. It’s important to understand “correlated” versus “non-correlated” investing as well.
Correlated simply means all one’s investments move the same as the stock market moves. A non-correlated investment does not directly follow the returns of the stock market.
Does it make sense for all your investments to be correlated to the stock market? I submit you should also have non-correlated investments. That’s where it could make sense to explore the four additional asset classes.
Bringing it all together
Solving the money problem means questioning and exploring why you interact with money the ways you do. I think it requires you to take an active role in managing your financial life.
Is passive investing right for you? Is active? What about a combination? We live in a very binary and tribal time where it feels like we have to pick a side. In reality, two things can be correct at the same time. I believe there’s a place for active investment management, as well as passive investment management. Particularly as we’re entering a new era of investing.
We’ve also been conditioned to thinking about “financial planning” as investing, when it’s so much more than that. I like to think about planning like a jigsaw puzzle. In this metaphor, the pieces are all our financial goals and desires, as well as accounts, investment options, insurance policies, and legal documents.
While the individual pieces of the puzzle are important, the most important part is knowing what you want the puzzle to look like. Without knowing that, the pieces don’t matter as much. The first step is to figure that part out.
In service of helping you do that, you can access our Goals course for free.
It’s a mistake to think about your investments in a vacuum. Instead of solely focusing on your 401(k), also look at what you’re investing in within your other accounts. Take into consideration your asset allocation (mix of investments) as well as asset location (where you own your investments).
Once you take ownership, and start thinking about investing differently, I think you’ve become an active manager of your finances. And that’s a good thing.
As for whether or not you should invest in actively managed mutual funds or ETFs, we’re happy to have a chat to help you evaluate your situation. Connect with one of our Certified Partners to get any question answered.
If you’re ready to take control of your financial life, check out our DIY Financial Plan course.
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