A lot is being made of whether or not active investing is superior to passive investing. It’s hard to know which one is best, and a popular question I get asked is, “Which should I be?” The answer to that question is that it depends.
I grew up in Cincinnati, Ohio and spent a lot of time at Riverfront Stadium watching the Cincinnati Reds baseball team. During the 1970’s, and especially in 1975 and 1976, the “Big Red Machine” was the most feared team in baseball as they won back-to-back World Series those years.
Two of the best players on that team were Johnny Bench and Pete Rose. You might be thinking, “That’s nice Andy, but what on Earth does this have to do with active and passive investing?” A good question that I thought would become clearer and easier to understand with a baseball analogy.
Pete Rose is on everyone’s list as one of the best hitters in all of baseball history. He holds the Major League Baseball record for most hits at 4,256 and it’s not likely, in this day and age, that anyone will break his record anytime soon. Pete played in 3,562 games spanning 23 years. He stood at the plate 14,053 times over those years and hit 160 home runs with a lifetime batting average of .303…pretty impressive!
Johnny Bench is arguably the best catcher to have ever put on a baseball uniform. He’s also my boyhood hero. Johnny had 2,048 hits over 2,158 games and 7,658 plate appearances. He hit 389 homeruns and his lifetime batting average was .267.
Now that you know about my two all-time favorite baseball players, here’s the link between them and active/passive investing.
In my analogy, I’ll link Johnny Bench to active investing, I’d tell you that he didn’t really hit for average. He was known as a slugger, often times swinging for the fences. The good news is that, when he hit the ball, he hit it a long way. On the down side, Johnny Bench struck out 1,278 times in his career, compared with 891 walks. Active investing attempts to out-perform the market. Just like Johnny Bench, when active investment portfolios swing for the fence, sometimes they hit a homerun and sometimes they strike out. That’s not necessarily a bad thing. Active managers are more aggressive “at the plate” than passive managers. Sometimes they win and sometimes they don’t.
Pete Rose, on the other hand, wasn’t known as a power hitter; he was a leadoff batter for almost his entire career because he could get on base. Over the course of his 24-year career (remember, 14,053 times at the plate), Pete only struck out 1,143 times. By comparison, Johnny Bench played 7 fewer years and struck out more than 1,000 more times than Pete Rose. Passive managers, by design, don’t “swing for the fences;” they try to get on base. If they ever hit a home run, it’s a good thing for investors, but it’s not something that will happen very often, nor should an investor expect it. Passive managers attempt to “hit for average” more than anything else.
So, you might still be asking yourself, “Which is better?” One isn’t necessarily better than the other in my mind. The answer lies with each individual investor. As a Financial Advisor, my job is to help clients understand the difference between the two and, with a good understanding of all the important factors, help clients make a decision about whether or not they’re more like Pete Rose or Johnny Bench.
There’s nothing wrong with having both types of accounts. In one portfolio, it’s perfectly fine to have actively managed accounts alongside passively managed accounts. One last analogy: Johnny Bench likely drove in Pete Rose many times over his career; they were both key players just as active and passive portfolios can complement each other.