Updated: Mar 7
Normally, when we speak about active and passive investing, we are comparing two highly debated investment strategies. Active investing usually employs a portfolio or money manager that charges a fee to make specific investment selections, trades, re-balancing, and tax management of an account. Whereas passive investing usually uses a buy and hold strategy typically with index funds that follow one of the major indices like the S&P 500 or Dow Jones. The debate centers around the costs associated with each of these investment strategies and whether it affects your overall portfolio performance. There is credible research on both sides of this debate. The bottom line is there are pros and cons to each of these strategies. The use of one or the other is dependent on the individual investor’s desires and their specific circumstances.
However, some investors tend to equate this choice in investment strategies to their choice of whether or not to engage a financial advisor, not realizing that these are two distinct financial decisions. Because of their choice of investment strategies, the passive investor tends to manage their finances on their own and the active investor many times hires a financial professional to assist them. Studies show that despite your choice of investment strategy – passive or active – there are benefits to having a professional financial advisor. Vanguard, one of the world’s largest passive investment companies, has been examining this question for 15 years. Based on their research, analysis, and testing, Vanguard has concluded that, yes, there is a quantifiable increase in return from working with a financial advisor. A separate study by Russell Investments, a large active money management firm, came to a similar conclusion.
There are several factors that lead to this advantage. Having a solid asset allocation strategy based on your personal tolerance for risk and your goals, resources and time frames. Making rational, not emotional, decisions with your money. Creating a comprehensive financial plan that works for you and your family. These variables will play a significantly greater role in the overall return of your portfolio than an active or passive investment strategy ever will.
A financial plan may sound like a chore. There are no passive financial plans. The very nature of financial planning requires you take an active role. But for successful investors, it’s the foundation on which to build, understand and achieve your goals. Having a written plan can increase confidence and result in more constructive financial behavior. However, the potential value of financial advice may vary based on the nature of the planning engagement. People working with a financial planner who is taking a holistic look at their needs, beyond just products and portfolio, are likely better off than those working with a financial advisor who takes a transactional approach. For this reason, I recommend engaging a Certified Financial Planner ™ professional.
The idea of active vs. passive takes on a very different meaning when discussing impact investing. The Global Impact Investing Network (GIIN) succinctly defines impact investing as “investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return”. Whether you actively or passively participate, there are benefits to this type of investing. If you haven’t picked up on this theme by now, I’ll say it for you. By investing in a sustainable way, and assuming that it aligns with your values and you’re completely committed, you’ll sleep better at night knowing that you’re trying to do good in the world. Although none of us are perfect, most people genuinely want to do some good in the world. If you can invest your money in sustainable, responsible and impact companies, and make a profit doing so, you’ll have two things to feel good about–making money and using your money to improve the human condition – having an impact.
There is a spectrum of active vs. passive impact investing and you can choose the level that you would like to participate. At the beginning of the scale is simply making a conscious effort to invest in companies and funds that have a sustainable, socially responsible, ESG (environmental, social and governance), and impact moniker. Naturally, the next question is how do I know that these companies or funds are truly living up to their name? This leads to the next level of activity – doing some research and data gathering to determine whether these investments are actually having an impact. There are several rating systems to assist with this discovery and many more are being developed. Based on this knowledge, you may discover that your investments may or may not be having the impact that you desire. You then have another decision to make. You can simply change your investments to others that research shows are having an impact. Or, you can take the next step along the path to become an active investor that seeks to make a change – shareholder advocacy.
Shareholder advocacy leverages the power of ownership to promote environmental, social, and governance change from within. This advocacy can take the form of a dialogue between shareholders and the company or shareholders may file a resolution, which must follow guidelines set by the United States Securities and Exchange Commission (SEC). Shareholder resolutions are a powerful way to encourage corporate responsibility and discourage practices that are unsustainable, unethical, or increase exposure to risk. Resolutions to be voted on are placed on the company’s proxy statement, and all persons and institutions that own stock in the company can vote on the issue. These resolutions enable a formal communication channel between shareholders and management that often results in the withdrawal of the resolution through a negotiated dialogue. If agreement is not reached, the resolution is placed on the company’s proxy statement and voted on by all stockholders.
So, you know all those pesky proxy mailings you receive in the mail? Now you know what they are for and what you could be doing with them. Again, this is where you can decide how active you want to be in the process. A financial professional can also assist here, either by helping you with your decisions or by recommending investments that actively participate in shareholder advocacy. With the increase in sustainable investing, there has been an increase in shareholder advocacy. This has resulted in new debates over shareholder power, legitimacy and urgency. I will cover more on shareholder advocacy in my next article and on an upcoming webinar. If you are interested in learning more, please continue to follow or give me a call!