Though indexing a passive investment strategy has been used by institutional investors for many years, it is still moderately new for the characteristic individual investor. Because ETFs use predominately passive strategies the first question any investor should consider is whether to take an active or passive approach to investing.
The main investment strategy today is active investing which attempt to break the market. The objective of active management is to beat a particular benchmark. Most of the popular mutual funds are actively managed.
Analyzing the market trends the economy and the company-specific factor, active managers are continuously searching out information and assembly insights to help them make their investment decision. Many have their own complex safety selection and trading systems to realize their investment ideas, all with the final goal of outperforming the market. There are roughly as many methods of active management as there are active managers. These methods can include fundamental analysis, technical analysis, quantitative analysis and macroeconomic analysis.
Active managers consider that the markets are inefficient, anomalies and irregularities in the capital markets can be exploited by those with skill and insight. Prices react to information slowly enough to permit skillful investors to steadily outperform the market.
Passive management or indexing is an investment management approach base on investing in exactly the same securities and in the same proportions. It is called passive because portfolio managers don't make decision about which securities to purchase and sale, the managers purely follow the same method of constructing a portfolio as the index uses. The manager’s objective is to duplicate the performance of an index as closely as possible. Passive managers invest in wide sectors of the market called asset classes or indexes and are eager to recognize the average returns various asset classes produce.
Passive investors consider in the Efficient Market Hypothesis (EMH) which states that market prices are always fair and quickly reflective of information. EMH followers believe that constantly outperforming the market for the professional and small investor alike is difficult. Therefore passive managers do not try to beat the market but only to equal its performance.
A debate about the two approaches has been ongoing since the early 1970s. The researchers from the nation's institutions and privately funded research centers supporting the passive management. Banks, insurance companies and other companies that have a vested interest in the profits from active management support the other side of the quarrel. Each side can make a strong logical case to support their arguments even though in many cases the support is due to different belief systems much like opposing political parties. Even if each approach has advantages and disadvantages that should be considered.
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