Active Indexing

Historically, there have been two separate and distinct strategies investors have used when investing in the stock market.  One is called “Active Management”, and the other is called “Passive Management” or “Indexing”.  At Topel & DiStasi Wealth Management, we use a strategy that takes a little from each of these methods (with a strong bias towards indexing), which is an investment strategy we like to call “Active Indexing”.  However, before we explain how it works, lets make sure we are clear on what active management is, what passive management is, and how they differ.

Active management entails the hiring of a manager to try and outperform an index, such as the S&P 500 or the Dow Jones Industrial Average. And, hopefully, to outperform other active portfolio managers as well.  In order to “beat” their respective indexes, the managers of these active funds often incur higher fees and taxes for their clients (the investor), due to the costs of trading and research, which they then pass on to the investor. 

Passive management (or indexing as it is more commonly known), on the other hand, does not rely on a manager’s skills in picking stocks, industries, or sectors.  Instead, passive management, as the name implies, is a buy and hold strategy.  The passive investment simply uses some type of mathematical formula to determine what stocks to hold in its portfolio, based on the index they are tracking.  Since there is no manger to pay, and usually very little trading, the costs for these types of investments are generally lower when compared to their active cousins.

Proponents of active management believe that a good stock-picker can beat the market, on an ongoing basis, through the use of superior research, and their stock-picking and market-timing abilities. If this is true, it makes sense to pay higher fees to a manager to pick investments for your portfolio, because you believe their superior insight allows for superior gains, and as such, they earn their fees by providing you a superior fee-adjusted return.

The followers of indexing, or passive management strategies, do not believe that any one person can consistently pick better investments than the rest of the mangers in his or her peer group, and as such, there is little or nothing to be gained from paying a manger.  The thought here is that it is better to keep costs low, and be the market, not increase fees by trying to beat the market.

So, the question is, who is right?  And the answer, as it often is – they both are.  In some time periods active managers beat indexers, and in some time periods indexers outperform active managers.  However, most research shows, that over the long-run, indexing beats active management, once fees and taxes are accounted for.

Based on these facts, we use a somewhat different investment philosophy that we believe takes advantage of the best attributes of both of the active and passive methods of investing and puts them to work for our clients. 

During our 20+ years of experience working in the financial markets, we have come up with three rules that we believe are irrefutable.

1.            Everything cycles.  What is hot in one time period is cold the next, and what is out of favor will eventually be back in.

2.            No one knows what the next best sector(s) of the market will be, or how long it will last. 

3.            Emotions, when investing, get in the way of the rational decision-making process.

Active Indexing portfolio management blends the lessons of these three rules into one comprehensive investment strategy.  It allows us to take advantage of the natural cycles of the market, and its individual sectors, and keeping emotions out of the equation.  The “Active” part of our strategy is the process of rebalancing and re-optimizing our portfolios based on market cycles. Not based on what we think will happen, but based on what actually has happened.  The “Index” part of our strategy refers to our use of very low-cost Exchange Traded Fund (ETF) indexes to fill our portfolio allocations. 

Our philosophy here is that if you believe the ultimate goal in investing is to buy low and to sell high, the best way to accomplish this is to systematically take money from the asset classes where you have made the most (or lost the least), re-invest that money in the asset classes that have lost the most (or gone up the least), and continuously re-balance your portfolio to take advantage of the cyclical nature of the market. 

By doing this, our goal is to ensure that we do not put our own preconceived notions or prejudices into the investment mix or get caught up in the “herd mentality.”  This may sound obvious, but if you were invested in the U.S. stock market in the 1990s you likely know how easy it is to get caught up in the hype, and make emotional, rather than rational, investment decisions.  By rebalancing systematically, we are assured of keeping our emotional, human nature out of the business of investing (Rule #3 – Emotions, when investing, get in the way of the rational decision-making process).

Once we have set up the original allocation, we are not tempted to let our emotion get in the way by making a statement like, “I think next year will be great for international stocks” (Rule #2 – No one knows what the next best sector(s) of the market will be, or how long it will last). Instead, we start the year with a certain percentage allocated to international stocks, and if they do well, we sell some to buy whatever has not done as well.   

We continue to do this over the years knowing that eventually what goes up must come down, and what has dropped in value will eventually rise (Rule #1- Everything cycles.  What is hot in one time period is cold the next, and what is out of favor will eventually be back in).    By continuously rebalancing our portfolios we are setting ourselves up to take advantage of these natural rotations in the market, whenever they occur.  We believe that by taking the emotion out of investing, by taking advantage of the natural swings of the market, and by keeping our product costs low, we can avoid the major mistakes made by most individuals when investing in the stock market.





The commentary on this website reflects the personal opinions, viewpoints and analyses of the Topel & DiStasi Wealth Management, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Topel & DiStasi Wealth Management, LLC or performance returns of any Topel & DiStasi Wealth Management, LLC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Topel & DiStasi Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.