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STA Weekly Report – Active vs. Passive Investing: There’s Room for Both

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Active vs. Passive Investing: There’s Room for Both
How to Choose Your Best Pension Annuity Option?
401k Plan Manager*Updated on 12/31/2018

Passive index funds continue to attract assets away from active investment managers and have led many to predict the ultimate demise of the active stock picker.

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Currently, passively managed investment funds have seen assets swell to more than $3 trillion and by some estimates now make up 45% of the market.

For some context, the market share for passive funds was considerably smaller in 2009. In fact, according to Morningstar, active managed funds held a 3 to 1 advantage over passive counterparts in the US just after the financial crisis. Looking globally, index fund and ETF assets swelled to nearly $10 trillion combined.

In 2012, the pace of money movement from active to passive accelerated because of the well documented benefits passive funds promise.

The Upside to Passive Funds

Passive investments undoubtedly offer great benefits.

First, there is typically a cost advantage due to less buying and selling in an underlying portfolio. As many investors know, cost can eat away at long-term returns and using passive investments can help in this area. This is all possible because nobody is doing the hard, time-consuming work of picking individual stocks. Instead, passive funds merely aim to follow an index or benchmark as closely as possible.

Second, passive funds offer significant transparency so investors know which assets they are buying and can understand the exposure being included in their portfolio. This is tremendously valuable considering that asset allocation is a big component of overall portfolio performance.

Third, because of how most passive funds handle trading, they can also be more tax efficient compared to their actively managed counterparts. The reason this occurs is that these passive funds won’t typically generate significant trading under the good that can generate massive capital gains taxes for the year. Lower taxes mean investors can hold onto more of an investment’s return.

With all these benefits, there are still some weaknesses to passive investments that investors should take into consideration. Most often cited are some limitations in scope and the difficulty outperforming the market. What we really mean is that passive investments track predetermined indices. This means that the passive funds will hold onto the index holdings even if the market plunges or if a specific company faces headwinds in their business that hurt its stock price, although the diversification offered in passive investments can help mitigate the idiosyncratic risk embedded in individual stocks.

The second major weakness is that passive funds will almost never beat its underlying index or benchmark. And in those rare cases when it does happen, it is largely by mistake and a rounding error.

The Upside to Active Funds

Like their passive counterparts, active funds also offer some benefits. Most notable are the ability to produce above-market returns and ability to profit from inefficiencies in the market. Although, it has become increasingly difficult for active managers to beat their respective index, it is still possible and in some instances is worth the increased fund fees.

Source: Gurufocus

Because of the strengths and weaknesses shared between both passive and active investments and the cyclical nature of their outperformance, we believe investors should mix both approaches. By doing so, investors improve diversification and give themselves the opportunity to outperform over time.

However, it should be said that to find an active manager worth the time, it is important to have a robust due diligence process. Investors should seek to scrutinize the managers track record and assess the strength and repeatability of their process. To find passive investments that fit an investment objective, it is equally important to utilize an analytical framework that seeks to understand the drivers of equity returns and provides a systematic approach to risk management. Bringing these two ideas together, while not guaranteeing outperformance, should improve the odds of doing so.

Weekly Global Asset Class Performance

If you have any questions, please feel free to email me at


STA Investment Committee

Luke Patterson, CEO & Chief Investment Officer

Mike Smith, President

Andrei Costas, Senior Investment Analyst (Equity Strategies)

Nan Lu, Senior Investment Analyst (Fixed Income Strategies)

How to Choose Your Best Pension Annuity Option

By: Scott Bishop, MBA, CPA/PFS, CFP® and
Elena Sharma, CFP®, RICP®

Executive Summary

In 2017, we wrote an article for STA clients titled, “How Do You Maximize Your Pension Plan.” In that article we shared an in-depth white paper on many things to consider when optimizing your pension plan in coordination with your financial plan. Please refer to the article for a full discussion regarding:

  1. Choosing between a Pension Lump Sum vs. a Life Annuity
  2. Issues to consider between annuity options.
  3. Calculation tool to evaluate the investment risk if you chose to take the pension as a lump sum.

In this article, we will be sharing a new tool helping you optimize your pension decisions between the various annuity options. These decisions may be the most important retirement decision you make, so they need to be thought through as part of a comprehensive retirement and financial plan.

Background on Traditional Pension Plans

If you participate in a traditional pension plan at work (technically known as a qualified defined benefit plan), you will generally be entitled to receive monthly benefits from the plan after you retire. These benefits are usually based on your age at retirement, your years of service, and your average earnings with the company. The normal form of benefit is typically a single life annuity. The single life annuity that makes monthly payments to you while you’re alive and stops upon your death.

If you’re not married at retirement, federal law requires that your benefit be paid as a single life annuity, unless you elect a different payment option. If you are married when you retire, federal law requires that your benefit be paid as a qualified joint and survivor annuity (QJSA), unless you elect another payment option. The QJSA is an annuity that pays monthly benefits to you while you’re alive, and continues to pay at least 50 percent of your benefit to your spouse upon your death.

Depending on your plan’s provisions, you may have other payout options to choose from as well. Any optional form of benefit offered by your plan must be at least as valuable (actuarially speaking) as the single life annuity. You’ll want to select a payment option that will provide you with sufficient retirement income. In addition, if you’re married, you’ll want to be sure that your spouse will have sufficient income in the event that he or she outlives you.

How can you choose the most optimal Pension Annuity Payout Option?

In the above referenced white paper, we describe in detail each annuity payout option, but there are both qualitative and quantitative factors in deciding which option is best for you.  If your pension only has annuity payout options, making the right choice can be one of the most important retirement decisions you make, and it should be coordinated with your overall personal financial plan.  For this decision, you must be able to answer the questions below (especially if you are married).  To help you better consider your options, we have created this decision tree:

Source: STA Wealth Management

Important Disclosure:
Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC (“STA”), or any non-investment related content, made reference to directly or indirectly in this article / newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article / newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  STA is neither a law firm nor a certified public accounting firm and no portion of the article / newsletter content should be construed as legal or accounting advice.  A copy of the STA’s current written disclosure Brochure discussing our advisory services and fees is available upon request. Please Note: If you are a STA client, please remember to contact STA, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. STA shall continue to rely on the accuracy of information that you have provided.


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