The Active Management Alternative to Online Advice’s Modern Portfolio Theory That Relies on Passive Investing — Part 3 of 3

Active management is the proven approach to sound investing.

In our second post, we used an example from online financial advisor to show how their recommended cash allocation lost nearly 8% for investors due to their proprietary computer algorithms that rely on a passive investing philosophy, combined with Modern Portfolio Theory.

In this post, we’ll look at the alternative to passive investing, Active Management.

What is Active Management?

The core philosophy of active management is hiring a human being, an experienced portfolio manager and real fiduciary, to monitor and adjust your portfolio based on market conditions today. Backward-looking computer models cannot capture future market scenarios. Active management adjusts for changes in the economy in real time to ensure the best-possible return on your investments.

We urge our subscribers to consider investor Charlie Munger’s philosophy on Modern Portfolio Theory (the belief in holding multiple asset classes, whether they meet your needs or not).

Charlie Munger, among other financial leaders who advocate active management, knows it is wise to simply invest in the best-performing investments that meet your needs. Today, we show you the results of placing your retirement savings in an actively managed Balanced Fund (funds that invest in both stocks and bonds) compared to a diversified, passive approach, based on Modern Portfolio Theory.

An Active Management Case Study

Active management is the proven safe approach to retirement investing

Active management is the proven safe approach to retirement investing

Yahoo Finance’s chart compares the results to an actively managed Balanced Fund with Betterment’s passively managed Diversified Portfolio, based on Modern Portfolio Theory, over the last decade:

  • NOMN-Researched Actively Managed Balanced Fund — Blue line (PRWCX)
  • Betterment Recommended TIPs ETF Fund (cash allocation) — Green line (TIP)
  • Betterment Recommended Equity ETF — Red line (VTI)
  • Betterment Recommended TIPs ETF Fund (cash allocation) — Purple line (SHY)
  • Betterment Recommended Equity ETF — Orange line (VEA)
  • Betterment Recommended Equity ETF — Yellow line (IVE)

Notice that the Not On My Nickel-research Balanced Fund not only has a far longer history than 10 years, it also generates better returns than any of the other passively managed funds, selected with Modern Portfolio Theory in mind.

In sum, if you had invested in Betterment’s ETFs, your performance would have been less than investing in one strong Balanced Fund. Strong means a fund with a decades-long track record of outperforming its index, after fees! The ETFs’ performance (above) is before advisory fees!

Why Active Management is The Best Approach

Modern Portfolio Theory is grounded in investing in a broad range of asset classes, whether they meet your needs or not. This approach cannot capture the unprecedented relationship between stocks and bonds we are seeing today and most often dilutes the returns from your equity allocation.

Unprecedented means computer algorithms have no history to base their calculations so they blindly invest in all asset classes, per Modern Portfolio Theory, with the double blow of investing in low-performing passive investments, like the ETFs you see above.

The Not On My Nickel-researched Balanced Fund hedges against what many economists and analysts are predicting — volatile swings in both the bond and equity markets. Actively managed funds are more nimble because portfolio managers can react quickly during unforeseen economic conditions, based on human analysis and touch.

What’s an Investor to Do?

If you are currently invested in passively managed funds recommended by a Modern Portfolio Theory-based computer model, make the switch to active management, with a portfolio manager with a long track record and low fees.

Online financial advisors may be a new trend, but it’s the safe and sound investing choice to put your retirement savings with a proven, active portfolio manager.

Why dilute your returns when the current best place to invest, according to many analysts, is mainly in the United States? By diversifying into so many different asset classes you are diluting your returns.

Here’s a last thought. Betterment’s website shows overall returns for their strategy, a Modern Portfolio Theory-based approach, of 4.91% from 2002 to 2012.

One of NOMN-researched Balanced Funds returned 10.13% for the same period.

Do not dilute your returns with poorly performing asset classes and passive computerized investment recommendations that may be out of sync with current economic scenarios.


* Yahoo Finance only allows for comparison of five investments, so we were unable to include every Betterment recommended option.

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