Journal article after journal article is replete with evidence that passively managed portfolios outperform actively managed portfolios. Unknown factors in failed actively managed portfolios are not specified and we don’t know what management style is used to chart the direction of the portfolio. We generally conclude that actively managed portfolio fail due to the manager selecting the wrong stocks at the wrong time. The assumption of selecting “wrong stocks” covers a wide range of errors. Perhaps the manager was working in an area (international stocks for example) where the market was weak and an incorrect benchmark was used to measure performance. There is a wide array of reasons for failure. One of the major portfolio drags is tied to expenses professional managers cannot avoid as they need to be paid for their services. As do-it-yourself investors, we eliminate management expenses.
What we do know is that over a lifetime of investing, while not impossible, selecting individual stocks is not a sure-fire way to outperform the market index. The best evidence of this fact is the poor performance of professional money managers. Here are a few references to back this claim.
Richard Ferri, in his book, The Power of Passive Investing, lays out the strongest case for passively managing a portfolio.
There you have the case for passive management. But what about active management as it pertains to the Momentum Model? Where does The Feynman Study and the Rutherford Model fit into portfolio management? Search “Robust ITA” and read the series of articles on all the back-testing of the ITA Wealth Management Model. There certainly seems to be a strong argument for active management if one wishes to avoid deep bear markets as we experienced twice in the last fifteen years.
One alternative is to use a blend of both passive and active management. In other words, attempt to take advantage of the best of both worlds. How does one go about building a blend or Mosaic portfolio? Below is an example, and to remove the “luck-of-review-day” I will use the Tranche spreadsheet.
Tranche Recommendations: This is what a Mosic portfolio might look like if “fixed” shares are purchased in the seven most basic ETFs and the tranche model is used to fill out the remainder of the portfolio. To explain how I arrived at this point, check out this “Camtasia” on building a Mosaic or blend portfolio.