Active Versus Passive Investing: Should You Try to Beat the Market?

The market may ultimately be efficient, they argue, but it sometimes takes a while for significant information to be priced into stocks because it is not yet generally known or noticed. For example, because U.S. investors pay less attention to small-company international stocks than they do to domestic ones, this may reduce efficiency, allowing well-informed, quick-thinking investors to invest on positive new information ahead of the pack, buying before run-ups.

Whether you're active or passive, the key is to manage your risk. Even a naïvely assembled stock portfolio that is well diversified can gird you against damage from a sliding market, though many such investors would be better off investing in mutual funds managed by professionals with proven records of containing risk. Passive investors can build in their own risk management by buying index funds pegged to widely varying indexes.

Ed Easterling of Crestmont Research talks about two market climates: a positive climate, in which you can just set sail and let kind market winds propel your portfolio vessel in the right direction, and a difficult one that requires you to laboriously row to reach your goals. Because of the current global economy, which includes recession forecasts for Europe, I don't believe Easterling's beneficial climate is on the horizon. If you disagree, you might want to go heavy on passive investments. But if you agree with me, you should use some active investments to get where you want to go.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

Ted Schwartz, a certified financial planner, is president and chief investment officer of Capstone Investment Financial Group. He advises individual investors and endowments, and serves as the adviser to CIFG UMA accounts. Because Schwartz has a background in psychology and counseling, he brings insights into personal motivation when advising clients on how to achieve their wealth management goals. Schwartz holds a B.A. from Duke University and an M.A. from Oregon State University. He can be reached at ted@capstoneinvest.com.

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