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  • Thorley Wealth Management, Inc.Elizabeth Thorley, MS, CFP, CLU, AIFCEO & President1478 Marsh RoadPittsford, NY 14534585-512-8453 x203Fax: 585.625.0477ethorley@thorleywm.comwww.thorleywm.com

    Active vs. Passive PortfolioManagement

    October 26, 2015

    One of the longest-standing debates in investing isover the relative merits of active portfoliomanagement versus passive management. With anactively managed portfolio, a manager tries to beatthe performance of a given benchmark index by usinghis or her judgment in selecting individual securitiesand deciding when to buy and sell them. A passivelymanaged portfolio attempts to match that benchmarkperformance, and in the process, minimize expensesthat can reduce an investor's net return.

    Each camp has strong advocates who argue that theadvantages of its approach outweigh those for theopposite side.

    Active investing: attempting to addvalueProponents of active management believe that bypicking the right investments, taking advantage ofmarket trends, and attempting to manage risk, askilled investment manager can generate returns thatoutperform a benchmark index. For example, anactive manager whose benchmark is the Standard &Poor's 500 Index (S&P 500) might attempt to earnbetter-than-market returns by overweighting certainindustries or individual securities, allocating more tothose sectors than the index does. Or a managermight try to control a portfolio's overall risk bytemporarily increasing the percentage devoted tomore conservative investments, such as cashalternatives.

    An actively managed individual portfolio also permitsits manager to take tax considerations into account.For example, a separately managed account canharvest capital losses to offset any capital gainsrealized by its owner, or time a sale to minimize anycapital gains. An actively managed mutual fund cando the same on behalf of its collective shareholders.

    However, an actively managed mutual fund'sinvestment objective will put some limits on itsmanager's flexibility; for example, a fund may berequired to maintain a certain percentage of its assets

    in a particular type of security. A fund's prospectuswill outline any such provisions, and you should readit before investing.

    Passive investing: focusing on costsAdvocates of unmanaged, passiveinvesting--sometimes referred to as indexing--havelong argued that the best way to capture overallmarket returns is to use low-cost market-trackingindex investments. This approach is based on theconcept of the efficient market, which states thatbecause all investors have access to all thenecessary information about a company and itssecurities, it's difficult if not impossible to gain anadvantage over any other investor. As newinformation becomes available, market prices adjustin response to reflect a security's true value. Thatmarket efficiency, proponents say, means thatreducing investment costs is the key to improving netreturns.

    Indexing does create certain cost efficiencies.Because the investment simply reflects an index, noresearch is required for securities selection. Also,because trading is relatively infrequent--passivelymanaged portfolios typically buy or sell securities onlywhen the index itself changes--trading costs often arelower. Also, infrequent trading typically generatesfewer capital gains distributions, which means relativetax efficiency.

    Note: Before investing in either an active or passivefund, carefully consider the investment objectives,risks, charges, and expenses, which can be found inthe prospectus available from the fund. Read itcarefully before investing. And remember thatindexing--investing in a security based on a certainindex--is not the same thing as investing directly in anindex, which cannot be done.

    Blending approaches with assetallocationThe core/satellite approach represents one way toemploy both approaches. It is essentially an asset

    Proponents of activeportfolio managementbelieve that a skilledinvestment manager cangenerate returns thatoutperform a benchmarkindex. Advocates ofpassive investing arguethat the best way tocapture overall marketreturns is to use low-costindex-based investments.

    Page 1 of 2, see disclaimer on final page

  • Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2015

    Securities and advisory services offered through Commonwealth Financial Network member www.FINRA.org/www.SIPC.org , a RegisteredInvestment Adviser. Fixed insurance products and services offered through Thorley Wealth Management, Inc. This material has been providedfor general informational purposes only and does not constitute either tax or legal advice. Investors should consult a tax or legal professionalregarding their individual situations.

    allocation model that seeks to resolve the debateabout indexing versus active portfolio management.Instead of following one investment approach or theother, the core/satellite approach blends the two. Thebulk, or "core," of your investment dollars are kept incost-efficient passive investments designed tocapture market returns by tracking a specificbenchmark. The balance of the portfolio is theninvested in a series of "satellite" investments, in manycases actively managed, which typically have thepotential to boost returns and lower overall portfoliorisk.

    Note: Bear in mind that no investment strategy canassure a profit or protect against losses.

    Controlling investment costsDevoting a portion rather than the majority of yourportfolio to actively managed investments can allowyou to minimize investment costs that may reducereturns.

    For example, consider a hypothetical $400,000portfolio that is 100% invested in actively managedmutual funds with an average expense level of 1.5%,which results in annual expenses of $6,000. If 70% ofthe portfolio were invested instead in a low-cost indexfund or ETF with an average expense level of 0.25%,annual expenses on that portion of the portfolio wouldrun $700 per year. If a series of satellite investmentswith expense ratios of 2% were used for theremaining 30% of the portfolio, annual expenses onthe satellites would be $2,400. Total annual fees forboth core and satellites would total $3,100, producingsavings of $2,900 per year. Reinvested in theportfolio, that amount could increase its potentiallong-term growth. (This hypothetical portfolio isintended only as an illustration of the math involvedrather than the results of any specific investment, ofcourse.)

    Popular core investments often track broadbenchmarks such as the S&P 500, the Russell 2000Index, the NASDAQ 100, and various internationaland bond indices. Other popular core investmentsmay track specific style or market-capitalizationbenchmarks in order to provide a value versus growthbias or a market capitalization tilt.

    While core holdings generally are chosen for theirlow-cost ability to closely track a specific benchmark,satellites are generally selected for their potential toadd value, either by enhancing returns or by reducingportfolio risk. Here, too, you have many options. Good

    candidates for satellite investments include lessefficient asset classes where the potential for activemanagement to add value is increased. That isespecially true for asset classes whose returns arenot closely correlated with the core or with othersatellite investments. Since it's not uncommon forsatellite investments to be more volatile than the core,it's important to always view them within the contextof the overall portfolio.

    Tactical vs. strategic asset allocationThe idea behind the core-and-satellite approach toinvesting is somewhat similar to practicing bothtactical and strategic asset allocation.

    Strategic asset allocation is essentially a long-termapproach. It takes into account your financial goals,your time horizon, your risk tolerance, and the historicreturns for various asset classes in determining howyour portfolio should be diversified among multipleasset classes. That allocation may shift gradually asyour goals, financial situation, and time frame change,and you may refine it from time to time. However,periodic rebalancing tends to keep it relatively stablein the short term.

    Tactical asset allocation, by contrast, tends to bemore opportunistic. It attempts to take advantage ofshifting market conditions by increasing the level ofinvestment in asset classes that are expected tooutperform in the shorter term, or in those themanager believes will reduce risk. Tactical assetallocation tends to be more responsive to immediatemarket movements and anticipated trends.

    Though either strategic or tactical asset allocation canbe used with an entire portfolio, some moneymanagers like to establish a strategic allocation forthe core of a portfolio, and practice tactical assetallocation with a smaller percentage.

    Note: Asset allocation and diversification aremethods used to help manage investment risk; theydo not guarantee a profit or protect againstinvestment loss.

    All investing involvesrisk, including thepotential loss of capital,and there can be noguarantee that anyinvesting strategy will besuccessful.

    A portfolio invested onlyin companies in aparticular industry ormarket sector may not besufficiently diversifiedand could be subject to asignificant level ofvolatility and risk.

    Page 2 of 2

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