There are generally two approaches to investment management: (1) active management and (2) passive management. Active management focuses on market timing and security selection in an attempt to earn above market returns. Passive management focuses on sensible asset allocation and broad diversification to capture the returns given by the market while minimizing costs, mitigating downside risk, and increasing tax benefits.
It is our belief that markets are generally efficient. We say generally efficient because markets are occasionally prone to significant pricing errors due to crowd behavior and investor biases. However, these pricing errors, which are evidenced in the dot-com bubble and the housing bubble, happen randomly and their ultimate corrections are never rational or predictable. There is an old saying in the investment industry that "the market can stay irrational longer than one can stay solvent." Sometimes we can perceive that a market is significantly over- or under-valued, but history has shown that such markets can remain inefficient for months or even years. The only case where we recommend active management is in our alternative investment program.
Active Management Generally Fails
Consequently, we believe that efforts of market timing and "stock picking" are futile. Instead, our firm focuses on the use of asset allocation to capture returns from the market. History and empirical research show us that more than 90% of the variation of a portfolio's return across time can be explained by asset allocation policy, not market timing or stock selection.* Focusing on capturing market returns through a passive investment approach also allows us to minimize trading costs, mitigate downside risk, evaluate investor biases and plan for better tax efficiency.
Despite the common sense logic of passive investment management, many investors and investment firms continue to subscribe to the active management approach. However, over the long term, research has shown that it is very difficult to succeed consistently with active management. It becomes an application of probability and statistics, where risk management and discipline is paramount. Many financial advisors who proclaim adeptness in actively outperforming the markets will most likely be charging higher fees and you will sustain higher commissions and transaction costs, some of which will be obscure or inconspicuous. If you choose an active investment program, be sure to understand all the risks and fees associated with the account.
Passive Management: The Sensible Approach
As a result of our research and education, the traditional investment philosophy of Rymer Wealth Management (RWM) is a passive approach, based on solid investing principles and Nobel Prize winning research, that attempts to capture long-term market returns. As part of our passive approach we believe in:
- educating the client on her investing biases and how they may affect her portfolio and strategy
- minimizing trading costs and account fees
- planning for efficient tax loss harvesting
- mitigating downside risk and volatility pursuant to the client's Investment Policy Statement
- diversifying portfolios broadly across different asset classes
* Gary P. Brinson, Brian D. Singer, and Gilbert L. Beebower, Determinants of Portfolio Performance II: An Update, The Financial Analysts Journal, 47, 3 (1991).