To illustrate how this would work in a real-life example, let’s look at Amazon.com and Pepsi. An index fund might own both of these companies, regardless of their respective financial prospects, just because they are in the index. An active fund could have tried to determine which investment would increase more in value over time and buy only that one.
So what does all of this mean to you the investor? I would argue that whether you prefer to invest actively or passively will not matter as much as many people think. The market is not something we can control, so we focus on the things we can, starting with the right allocation of stocks to bonds according to your risk tolerance and capacity to handle the ups and downs of the stock market. A good allocation will also consider different kinds of assets and which accounts you should own them in. It is also important to get the non-investment aspects right, too, that is, having the right types and amounts of insurance, paying as little in taxes as possible while correctly preparing your returns, getting the most out of your company or government benefits, and being smart about debt. The active or passive debate loses some of its importance in the light of a well-designed and comprehensive financial plan.
Still not sure what to do? Give The Financial Consulate a call at 410-823-7283.