Active vs. Passive Investing


Definition of active versus passive management

The difference between active and passive management is quite simple on the surface. Active management is just what it says it is: the active management of your portfolio by choosing investments on a continual basis, including when to buy and when to sell. It may include overweighting certain stocks or sectors while underweighting or avoiding others. And while individual stock selection is considered active management, so is choosing fund managers that invest in individual securities. Throughout this article I will refer to both individual stock selection and mutual fund manager selection as active management.

Passive management is not necessarily the opposite of active management, but rather, a strategy of investing in an index or sector, through a passive exchange traded fund (ETF) that is representative of a market. While this concept has evolved due to the proliferation of ETF’s focused on narrow segments of the market, the concept remains the same. For example, the iShares S&P 500 Index ETF (SPY) invests in all of the stocks included in the S&P 500 in the same proportions that those stocks represent the index. The iShares S&P Global Technology Sector ETF is also a passive investment, but is more focused on the technology sector specifically.

Stock Selection Process: The Quantitative Screen

Stock Picking Process - Quant Screen

With so many individual stocks in the global equity markets to choose from, it is important to be able to follow a disciplined process for finding, evaluating, and monitoring stocks. In this article, I will focus on the initial step required to reduce the universe of stocks to a manageable number.  In future articles, I will address the detailed analysis required for evaluating stocks and the monitoring process once a stock has been added to the portfolio.