When deciding whether to opt for active or passive management of your investment dollars, there’s one key aspect you shouldn’t overlook – and it has nothing to do with finance.
Investors often think asset mix, market variables or allocation are the most valuable parts of active management, but many wealth managers spend the majority of their time managing their clients themselves.
“The October – December (2018) stretch was a great example where it’s not so much the investment that matters, it’s the behavioural psychology of knowing that your time horizon, your objectives, your risk tolerance didn’t change, but the market’s looking pretty scary given the volatility,” said Jordan Damiani, a senior wealth advisor with Meridian.
“Sometimes it’s good to have a sober second thought and have somebody to talk to about that, before just clicking a button and placing a sell.”
That kind of impulsive reaction can affect your returns for the next decade – whether you have active or passive management, he added.
Traditionally, investors had two options: active management, which involves having a portfolio manager trying to actively outperform the stock market and manage volatility by picking specific stocks, bonds or cash – for a fee.
They could also opt for passive management, or index investing. With this approach, you’re basically buying the whole stock market (through an index mutual fund or ETF) with the goal to track returns of the market. Passive is often seen as a safer and cheaper way to invest, since fees tend to be low and packaged without advice. ETFs are often lumped into this category, but these exchange-traded funds can actually be passive or active.
There’s a third option, that’s a hybrid of the first two: passive management, with a bit of help.
“There’s a lack of awareness about this hybrid approach, where we say – we’re not going to try to do anything fancy on the investing side because we think it just doesn’t add much value over the long run, but where we’re going to add value is the behavioural supports and habits, because those have been proven to cause way more harm in the long run than a few tens of a percent in fees,” said Kevin Langman, a fee-based financial planner in Calgary who works with many millennial clients and is the co-founder of Finovo.
“People who just stick to the plan do much better.”
It’s also important to make sure you understand everything you’re entitled to with any option you choose.
“You’re not getting what you paid for if you have, effectively, an active mutual fund (where) the cost of an advisor is embedded and you’re not meeting with anybody, there’s no planning being done, there are no touch points – then there’s no value-add there, and all you’re getting is the investment piece,” said Damiani.
“If there isn’t that outperformance on the active side – whether we focus on advice or not – then you’re not getting value relative to what the index is doing over time.”
While part of the difficulty stems from a lack of standardization that makes it difficult to judge what you can get from one fund or manager compared to another, one of the biggest culprits is under education.
“Personal finance is not taught to anybody at any educational level, so people don’t have the basic tools to understand (how) these plans work,” said Damiani.
“There’s (also) a pretty big gap in our industry in terms of smaller accounts.”
For those just starting out, Finovo’s Langman recommends passive, index-based investing.
“For a lot of people a robo advisor is a good option, especially … those under $50,000 or $100,000,” he said.
“Your investment is going to be spread across hundreds of companies, and all you really have to do is say, ‘I want to contribute $500 a month’ … It goes automatically; you don’t even have to think about it and your money is just getting invested and growing over time.”
Whatever way you choose to go, make sure it’s cost-effective, competitive and quality – and that it allows you to continue to save toward your long-term goals.
“Too many people get hung up on what’s the best way to save … and then they never do anything because they’re stuck in this analysis paralysis,” said Langman.