Active vs. passive investing: Be passive for the long haul

— -- Q: I've noticed some active stock investors are capitalizing on the market's recent upswing. Does that mean passive indexing is dead?

A: The debate between active and passive investors still rages. And it probably always will.

Just so you understand the difference, active investors believe they can beat the market by buying the right investments at the right time. Some do fundamental research to see which stocks might be cheap or where earnings in the future might pick up. Active investors also try to buy stocks when the prices are depressed.

Passive investors, on the other hand, believe that chasing hot or cheap stocks is a waste of time. Most passive investors believe that market prices over time reflect the true value of investments. And while prices may be "wrong" for a short period of time, knowing when to buy takes luck and skill that most people — including a lot of professional money managers — don't have. Passive investors say active investors ring up such a price in time spent and in commissions, that their true profit is tiny or non-existent.

During times of market flux, as we've seen this year when stocks pulled out of a horrible bear market, it's natural to see some active management strategies working.

For instance, active managers who loaded up on emerging markets stocks are most likely beating the stock market this year. Emerging markets stocks continue to perform strongly from March lows. But those same managers most likely underperformed last year, when emerging markets fared much worse than U.S. markets.

That's the challenge for active management. It's always possible to be at the right place at the right time once or twice. But repeating that performance year after year is extremely difficult, if not impossible. In addition, active managers tend to charge lofty fees that eat into any marginal benefit they create.

Finally, as an investor it is difficult, if not impossible, to know ahead of time which active managers will be hot in the next year or decade. And once these skilled managers get discovered by mutual fund tracking services, they usually see a big influx of money. And many good mutual funds become poor funds when they get too big.