This strategy does not involve the selection of securities by a portfolio manager. Without a portfolio manager to track the way an index performs, the cost of using a passive strategy is extremely low. It has also been suggested that the additional value provided by a portfolio manager is canceled out by any fees, costs and taxes.
However, if you possess securities in that index, you will never outperform the index. In addition, if you use a passive strategy, and the market experiences a decline, you will take part in that decrease in value.
In contrast to passive investing, active investing uses a manager who tries to produce returns that exceed the index against which the portfolio is benchmarked. The majority of managers try to accomplish this by selecting stocks they believe are improperly priced in the stock market compared to what should be their actual value.
The two major benefits of using an active strategy are the potential to outperform the index and protection from a market decline. Managers and their employees may be able gain an understanding of companies that others may have overlooked. They have access to information that will enable them to execute a trade that can outperform the index. Moreover, they can increase cash by selling securities if they think the market is going to decline or they recognize issues concerning the companies before everyone else does.
A disadvantage of the use of an active strategy is the fees connected with a portfolio manager. The fund’s investors pay the salaries, rent, research and travel expenses for the manager and the manager’s team. An additional concern is that the manager may not be able to outperform the index on a regular basis.
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