The Fork in the Road: Choosing Between Active and Passive Investing

Passive investing involves several elements. As the name implies, passive investing follows a buy-and-hold methodology—an approach with little to no turnover in investments. Passive investing often involves holding multiple securities that represent the entire market (like the S&P 500 Index) without much regard to the merits of individual businesses or companies, giving you a highly diversified portfolio.

Passive investing is often celebrated for low costs, with some passive ETFs costing under 0.05% in annual management fees. If we map out the road to our investment goals, passive investing typically downplays the journey for the destination, even if the journey is downright disagreeable due to market volatility. As long as the destination is financial freedom, so be it.

Active investing takes a different path to aim for a similar outcome. Instead of buying every investment in a given category, active investing attempts to separate the wheat from the chaff by evaluating companies on their individual merits.

Let's say two companies operate in the same industry, but only one is profitable: if the profitable company also has growing sales and a loyal clientele, investing in that company might be a better choice. Active investing requires effort: active managers need to carefully analyze businesses and map out prospects, in order to deliver true value to investors.

Actively managed products typically carry higher management fees since research and an investment process are required. These are justified so long as the net return is superior to the passive outcome. Active investing focuses on the journey as well as the destination: it tries to manage the potholes and speed bumps on the road and attempts to avoid detours that might lengthen the journey.

The lines between active and passive ETFs are blurring. Consider a bespoke index ETF that evolves over time. TD Asset Management Inc. (TDAM) offers an ETF, the TD Global Technology Leaders Index ETF (TSX:TEC), that tracks a custom technology benchmark. We designed this index with Solactive, one of the largest ETF index providers in the world. Solactive administers the index and runs the quarterly rebalancing, but both parties meet annually to review the index constituents to ensure exposure to both traditional technology (for example, software and semiconductors) and leading-edge technology (for example, robotics and artificial intelligence). This hybrid-style ETF could be considered passive and active, since the portfolio changes over time.

How about a low-turnover portfolio with an options overlay? In the active ETF category, TDAM offers the TD Active Global Enhanced Dividend ETF (TSX:TGED), that buys and holds a narrow portfolio of high-conviction, well-operated global companies. This ETF seeks to add value by generating additional yield via call and put options. Layers of active management, as well as a strong track record, present an interesting option for global equity exposure, offering the potential for both yield and capital gains.

When I used to read the Choose Your Own Adventure books, I was always obsessed with taking the right path. I'd try to hedge my decisions and dog-ear the pages to ruin, so concerned with optimizing my journey that I'd use all my fingers as bookmarks, hedging my decisions so I could flip back and potentially make a different choice.

Consider the same approach when it comes to investing. When faced with purchasing active or passive investments, don't choose! Build a portfolio that reduces fees by investing in low-cost index investments, but also uses active ETFs that take advantage of inefficient markets. Create a model that focuses one eye on fees and the other eye on value, net of fees. Don't put a fork in the road (or a finger on page 45, 66 & 98). Consider purchasing both active and passive ETFs together.

These days, we have investment solutions that combine a number of passive ETFs in one solution, immediately diversifying portfolios and lowering costs. These can serve as core building blocks for your portfolio. Buy and hold and watch your assets grow over time but consider active ETFs on the periphery to add the potential for a smoother ride.

Whether our portfolios turn left, or our accounts turn right, we're still on the journey if we combine index and active ETFs: we get the best of both worlds, and all the benefits of each, offering the potential to enjoy both the adventure and the destination.

For more information on TD ETFs, please visit our website.

The information contained herein has been provided by TD Asset Management Inc. and is for information purposes only. The information has been drawn from sources believed to be reliable. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance.

Commissions, management fees and expenses all may be associated with investments in exchange-traded funds (ETFs). Please read the prospectus and ETF Facts before investing. ETFs are not guaranteed, their values change frequently, and past performance may not be repeated. ETF units are bought and sold at market price on a stock exchange and brokerage commissions will reduce returns.

Certain statements in this document may contain forward-looking statements (“FLS”) that are predictive in nature and may include words such as “expects”, “anticipates”, “intends”, “believes”, “estimates” and similar forward-looking expressions or negative versions thereof. FLS are based on current expectations and projections about future general economic, political and relevant market factors, such as interest and foreign exchange rates, equity and capital markets, the general business environment, assuming no changes to tax or other laws or government regulation or catastrophic events. Expectations and projections about future events are inherently subject to risks and uncertainties, which may be unforeseeable. Such expectations and projections may be incorrect in the future. FLS are not guarantees of future performance. Actual events could differ materially from those expressed or implied in any FLS. A number of important factors including those factors set out above can contribute to these digressions. You should avoid placing any reliance on FLS.

TD ETFs are managed by TD Asset Management Inc., a wholly-owned subsidiary of The Toronto-Dominion Bank.

TD Asset Management Inc. is a wholly-owned subsidiary of The Toronto-Dominion Bank.

®The TD logo and other TD trademarks are the property of The Toronto-Dominion Bank or its subsidiaries.