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Fiduciary Focus: Active vs. Passive Investing

How a fiduciary makes choice is central to fiduciary responsibilities.

W. Scott Simon, 02/03/2005

Active Investing and Passive Investing in the Context of Prudent Fiduciary Investing (Part 1)

This month’s article is the first in a series that examines active investing and passive investing within the context of modern prudent fiduciary investing.

Before going any further, I must disclose my own bias: I am committed to passive investing. I wrote a book in 1998 called Index Mutual Funds: Profiting from an Investment Revolution (now out of print) for which John C. Bogle provided the introduction. That book included some material on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule) that led me to write an article in a California legal periodical on index funds and the California Uniform Prudent Investor Act. That article, in turn, led me in 2002 to write The Prudent Investor Act: A Guide to Understanding.

While I did bring a predisposition to favor passive investing as I went about analyzing the process described in the Act and the Restatement in my latest book, I tried, nonetheless, to be as balanced as possible in presenting that analysis. I would, therefore, ask all those who are ready to fire off critical e-mail to me as a result of reading this series of articles to please remember that.

I would also ask those who are committed to active investing to remember that there is a big difference between investing your own money and investing money for others as a fiduciary. You can invest your money to your heart’s content in the latest, hottest investments, but the standards are a lot different when you invest money that’s not yours. This doesn’t mean that fiduciaries are restricted only to U.S. government bonds; it just means that there are certain rules of prudence by which fiduciaries must conduct themselves.

Two Fundamentally Different Approaches to Investing

A fiduciary implements the asset allocation for a trust portfolio with an appropriate investment strategy. Before selection of any investment strategy, it would behoove the fiduciary to understand the significant differences between two fundamentally different approaches to investing--active investing and passive investing.

The decisions made by a fiduciary in selecting either an active or passive investment strategy (or some combination of both) to implement a trust portfolio’s asset allocation stand at the very center of the issues surrounding fiduciary responsibility.

W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understanding is the definitive work on modern prudent fiduciary investing.

Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals.

For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.

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