Since the invention of money, people have found ways to grow it and, unfortunately, ways to lose it. New products, asset classes, and services constantly emerge, each promising unprecedented returns on investment. However, regardless of what’s trending in the markets, it’s essential to understand the basics—the time-tested strategies that investors have long relied upon to build wealth. The following are four of these time-tested styles of investing–the primary types of portfolio management that every investor should be aware of. Each offers distinct approaches, benefits, and challenges, allowing investors to choose the style that best aligns with their financial objectives and risk tolerance.
Active Portfolio Management
Definition
Active portfolio management is the archetypal style of investing–what most people think of when they hear the term “investing.” This hands-on approach involves making strategic decisions with the goal of outperforming the market, and typically involves the continuous monitoring and analysis of the market to identify opportunities for buying and selling assets.
Key Characteristics
Active management is characterized by frequent trading. As the name suggests, you are actively selecting and adjusting investments based on market trends, economic data, company performance, and more. Your primary goal is to “beat the market” by achieving returns that exceed the market average, often by capitalizing on short-term price movements.
Pros and Cons
The potential for higher returns is the main attraction of active management. However, this approach comes with higher risk, as frequent trading can lead to significant losses if market calls are incorrect. Additionally, transaction costs and fees can eat into your returns, making it a more expensive strategy.
Passive Portfolio Management
Definition
Passive portfolio management, which has been around since the 1970s, is a hands-off approach to investing. Instead of trying to outperform the market, you’re trying to match the broader market’s returns, typically by creating a fund that mirrors one of the major market indices, such as the S&P 500.
Key Characteristics
The key characteristic of passive portfolio management is its buy-and-hold strategy. Once investments are selected to match an index, they are held with minimal changes, i.e., you’re in it for the long haul. This approach often has lower costs due to fewer trades and lower fees, which can help maximize your returns.
Pros and Cons
Think of passive management as the “Goldilocks” method of investing. You will never underperform the market, but you will also never outperform it. Benefits include lower fees and reduced risk, making it an attractive option for long-term investors who are content with returns that match the market.
Discretionary Portfolio Management
Definition
Discretionary portfolio management involves entrusting a professional portfolio manager with the authority to make investment decisions on your behalf. The manager has complete autonomy to buy, sell, and adjust your investments without needing prior approval.
Key Characteristics
The portfolio manager tailors the investment strategy in discretionary portfolio management to align with your financial goals, risk tolerance, and time horizon. The portfolio manager’s expertise is crucial since they are responsible for making decisions that directly impact the portfolio’s performance.
Pros and Cons
The primary advantage of discretionary management is the personalized, professional management it offers. Clients benefit from strategies tailored to meet their specific needs and goals. This approach will be more costly, as it will incur higher management fees. However, you will receive the expertise of a professional investor who is working for you on a daily basis.
Non-Discretionary Portfolio Management
Definition
Non-discretionary portfolio management involves a more collaborative relationship between you and your portfolio manager. While the portfolio manager provides advice and recommendations on how to invest, you retain the final decision-making authority over all investments.
Key Characteristics
Although you are paying for professional expertise, you have the final say on all investment decisions. Again, it’s collaborative. The portfolio manager’s role is to provide you with expert guidance to help you make informed choices that align with your investment objectives.
Pros and Cons
This method of investing allows for a balance between professional advice and personal control. You remain actively involved in your portfolio while benefiting from expert advice. One potential disadvantage of this method of investing is that it could lead to delays in decision-making, as it requires a higher level of your involvement.
Tried and True
There are many different ways to invest, but these four styles represent the foundation of portfolio management. They have stood the test of time and will likely continue to serve investors well into the future. A good portfolio management services firm will offer all these options (and maybe even a few more).
Understanding the different styles of portfolio management is crucial for making well-informed investment decisions. Each of the styles offers advantages and challenges. The right choice depends on your goals, risk tolerance, and desired level of involvement in managing your investment portfolio. Consulting with a portfolio management services firm is always a good place to start.