A new research paper by Vanguard provides a framework for the decision between active and passive investing, according to an article on the company’s website.
The paper intends to help the decision-making process by “enabling investors to think more explicitly about their expectations and the risks they’re willing to accept.” Here are some variables the paper cited as important for investors to consider:
- Gross alpha expectation—the “ability to achieve successful outcomes through skill in selecting an active manager”;
- Cost of active management—”low cost is the most effective quantitative factor an investor can use to improve the chance of success;”
- Active risk—the degree of volatility a fund demonstrates relative to its target benchmark and the level of certainty with respect to any particular fund manager;
- Active risk tolerance—how much risk an investor is willing to take.
According to the article’s author, Daniel Wallick–principal at Vanguard Investment Strategy Group and lead author of the paper—indexing is a good starting point for investors, but it’s not as simple as choosing to go all passive or active. “Although some investors may view the active-passive decision as all-or-nothing, Vanguard believes it’s more nuanced.” He adds that if an investor can tolerate some degree of risk associated with what they view as a talented an active manager whose fees are not too high, an allocation to active “may be appropriate.”