Determining the appropriate level of activity in portfolio management requires careful consideration. Clients frequently ask why we don’t just invest everything in an index fund and leave it at that. The question still remains, how often should we be trading client accounts?

A favorite quote of mine regarding this concept comes from my mentor, Arty Finkelberg, who told me everyone always has a great reason to buy, but only the good ones know when to sell. This sage piece of advice goes beyond the old adage of “buy low sell high”, because you should only buy something if you know at what price you’d be willing to sell it. Whether you are actively managing each individual holding, have a broad mix of exposures, or simply following an index fund, knowing when you want to sell is often the most important piece of your investment puzzle.

Index funds are investments that follow an index such as the S&P 500 or Barclays Aggregate Bond and attempt to match the performance of that underlying index, minus any management fees. These investments are considered “passive” because they don’t try to pick which stocks, bonds, etc. will outperform the index. They are just getting matching exposure. You can access index investments several ways including mutual funds, exchange traded funds (ETFs), or even by building your own in a process called “direct indexing”. Index funds now hold more assets than active funds in terms of assets under management according to CNBC [1] and have shot up in popularity due to their simplicity and cost.

While they seem simple, and in many cases are, index investing can be very complicated and the index you choose can have a huge impact on your performance. As an example, two of the widest followed Small Cap U.S. indexes are the Russell 2000 and the S&P 600. Besides having a completely different numbers of stocks between the two, the stocks themselves and their selection process varies greatly. Among other items, the S&P 600 mandates that there is a minimum profitability level for any company in the index whereas the Russell 2000 does not. It is crucially important to know what you’re looking for before making an investment into an index, otherwise you may find yourself owning something you’d rather not.

Taking it a step further, when most people think of indexes they think of “market capitalization weighted indexes”, which means the investments with the highest weightings are the biggest by the size of their available stock. This is how the S&P 500 is constructed. There are many other ways of constructing an index, however, and those may be appropriate depending on your goals. As an example, you can screen out only profitable companies as above, or you can say I want to own companies with the highest dividend yields. These are called “factor based” investments where you are selecting specific attributes that you believe will do better. There is no one actively picking stocks and there are indexes that follow these types of investments, so they do tend to fall into the realm of “passive indexes”. These strategies may be cheaper than paying a stock picker but can be more expensive than a pure benchmark-based index fund. Importantly, when you buy a market capitalization weighted investment you are, by definition, buying yesterday’s winners in what is known as a momentum trade. There can be risks associated with momentum trading as fortunes sometimes quickly turn.

The opposite of passive investing is “active” investing where the goal is to outperform a stated benchmark by picking winners and losers. In other words, is Coke a better stock than Pepsi. This investing strategy can be applied across virtually any asset class and is similar to how I manage money – which I’ll touch on later. The problem with active management is that it is easy to get wrong. What if you bought Coke and you should have bought Pepsi? The fear of getting something wrong or missing out (FOMO) increases the appeal of benchmark investing because it removes that risk. The upside is you may outperform the market and in some cases the rewards can be substantial. Typically, actively managed strategies are the most expensive.

There are many good reasons to hold index investments, both market capitalization weighted, and factor based. Low cost, simple, and easy to research – the reason for their popularity is evident. For some investors, taking a more active role in managing the individual pieces of a portfolio may lead to greater rewards over time and some managers have more than justified their costs. I offer both purely passive portfolios, alongside partially active and customized solutions to help meet our client’s needs. Regardless of what style you prefer, knowing how active to be with your holdings and when to sell is critical to your success. 


* Indices are unmanaged portfolios of specified securities. Individuals cannot invest directly in an index.

Recent Posts

Let’s Talk

If you are in need of expert wealth management services, we would be honored to assist you in helping you and your family reach your goals. With deep, unmatched investment, risk management and retirement planning expertise, we can help you and your loved ones plan for the future, just as we have for thousands of clients.