Perhaps the most important investment trend of the past 50 years has been the shift from active to passive management. Owning an S&P 500 or total market index fund was once seen as “giving up”—settling for mediocre performance. Yet over time, it became clear that “mediocre” wasn’t so bad. Many active managers promised to beat the market. Few could deliver over the long term, especially after accounting for fees.
The Bogle Rule
Vanguard founder Jack Bogle had the critical insight. Imagine you could neatly divide all investors into two groups: active and passive. The passive investors own the “market portfolio”—every stock in exact proportion to its market capitalization. That implies active investors, in aggregate, must also own the market portfolio. The active investors own everything the passive investors don’t! And so active investors, collectively, are destined to underperform passive investors by the amount of their fees and incremental transaction costs.
Active Investing: A Zero-Sum Game
The “Bogle Rule” doesn’t mean it’s impossible for active investors to outperform. It just means that active investing is a zero-sum game. For some active investors to outperform market benchmarks, other active investors must underperform.
Competition among active investors is intense, but many of them make their jobs even harder by:
• Trading too frequently, which increases transaction costs and taxes;
• Owning too many securities, which can lead to “closet indexing”;
• Focusing on short-term noise like macroeconomic and political headlines, rather than doing the hard work of understanding individual businesses; and
• Using distribution methods (e.g. selling through “brokers”) that involve multiple layers of fees.
The Trajan Wealth Difference
At Trajan Wealth, we believe there’s a better approach to active management:
• We do deep fundamental research to try to uncover high-quality, undervalued businesses.
• We manage portfolios focused on our best ideas.
• We keep turnover low to minimize transaction costs and taxes.
• We use in-house managers to oversee our portfolios, which avoids the extra layer of fees that come with external ETFs or mutual funds (even passive funds have some fees).
The only way for investors to achieve differentiated results is to be different in some way. We still see room for disciplined, capable active managers to outperform.
Active and Passive Both Have a Role to Play
That said, passive strategies are also an excellent foundation for many investors’ portfolios. They offer the broadest diversification, and often the lowest costs. We believe in giving investors a choice, because every client has their own unique financial goals and risk tolerance. Our strategy lineup ranges from broadly diversified ETF baskets to focused individual stock portfolios.
Quick Comparison
| Active Investing | Passive Investing | |
|---|---|---|
| Primary Goal | Beat the market | Match the market |
| Philosophy | Selectively own high-quality and undervalued businesses | Own the entire market |
| Management Style | Seek compelling risk/reward opportunities through deep fundamental research | Hands-off, buy and hold |
| Concentration | Hold fewer securities to focus on your best ideas | Extreme diversification |
| Costs & Fees | Generally higher, but can be avoided with in-house management | Low |
| Primary Risk | Analytical error leading to benchmark underperformance | Full exposure to market drawdowns and overvalued securities |
Contact a Fiduciary Advisor Today!
No matter what your investment style is, Trajan Wealth has a strategy for you. Contact us today to schedule your free portfolio review.
