The investment world is embroiled in a debate between the merits of “passive” and “active” investing. While passive investing has its place, I explain why we embrace a decidedly active role.

Individual investors who want to profit from the markets but don’t envision themselves as stock-picking wizards are opting instead for index funds and exchange traded funds (ETFs) that are largely managed via software algorithms — hence the term passive.

There’s been a proliferation of passive funds that track indices cheaply and others, called “smart beta” investments, that mimic elements of what humans do at far less cost. Since 2000, investors have removed $2.5 trillion from active funds and plowed roughly the same amount into passive ones. About two-fifths of the global industry’s equity assets are managed passively, up from nearly zero in 2000, according to research firm Sanford C. Bernstein.

These trends have pummeled the asset-management industry, with passive funds imposing fees that are up to 80% lower than their active counterparts. The industry’s most valuable company is BlackRock (NYSE: BLK), a behemoth in ETFs.

Last week, BlackRock announced that it would move 50 of its ETFs from NYSE Arca to homes on rival trading exchanges, underscoring the intensifying competition in the ETF realm. BlackRock, the world’s largest asset manager and issuer of ETFs, will move 30 of its iShares-brand ETFs to CBOE Holding’s Bats exchange and an additional 20 ETFs to Nasdaq. BlackRock currently manages $1.4 trillion in ETFs. NYSE has drawn criticism lately for glitches that impeded the trading of ETFs.

Index funds and ETFs are inexpensive — as well they should be, because they don’t incur the fees and commissions associated with more active trading. Index funds and ETFs charge annual fees that are only a small fraction of those charged by an actively traded fund, because the latter need highly paid “talent” to conduct research and conceive strategy.

The active/passive tug of war…

Where does Investing Daily stand on this debate? Ari Charney, chief investment strategist of Utility Forecaster, eloquently expresses our collective view:

“As retail investors continue their inexorable slouch toward passive investing, we remain champions of the active approach.

That’s not just out of self-interest. Although we’re primarily stock pickers, we believe pooled investment vehicles such as mutual funds and closed-end funds still play an important role in most investors’ portfolios, including our own.

And we don’t just want to settle for the performance of a particular index — or even one of those custom benchmarks Frankensteined together by the exchange-traded fund purveyors on Wall Street. When we invest in a fund, we actually hope to beat the market, at least over the long term.”

Ari also serves as the income expert on our flagship publication, Personal Finance. He adds this important qualification:

“But we’re also willing to go where the data take us. And if that means passive investing has produced superior returns in a particular niche, then we’ll happily concede it.”

To be sure, index funds and ETFs involve less stress. With an index fund or ETF, you’re not tempted to shift your funds from a loser to an ostensible winner. You’re liberated of desperate efforts to buy low and sell high. Emotion is removed from the equation.

The downsides to passive investing? Well, for starters, it’s really boring. But more importantly, your chances of getting rich through the passive approach are just about zilch. And besides, it’s not truly passive. You need to decide which fund is appropriate for your needs and goals; you also need to determine asset allocations.

Also keep in mind, it’s easier to be passive in an up market. This bull market is now more than eight years old and, as they say, a rising tide lifts all boats. The true test comes at low tide during a market crash, when investors face a strong temptation to sell — which is usually a mistake (and which turns them, ironically, into active managers).

The dangers of “Ostrich” investing…

It’s during times of uncertainty and turmoil that the active approach can make a big difference.

There are defensive and proactive measures that can not only protect your portfolio but also retain a growth trajectory — the sort of informed decisions undertaken on a daily basis by our investment strategists. The alternative is to bury your head in the sand.

Jim Pearce, chief investment strategist of Personal Finance and director of portfolio strategy for Investing Daily, has repeatedly warned of an imminent stock market correction. Jim explains how our active approach right now is protecting investors, while also giving them avenues for growth:

“The buy limits in the PF Growth and Income portfolio tables reflect what we believe are the maximum fair prices to pay for each stock, given the current market environment.

If we get the kind of correction we’re expecting, momentum stocks will get hammered pretty hard (of which we do not hold any). However, undervalued stocks with solid dividends and rising revenue streams should end up being rewarded (of which we hold many), as investor capital is redistributed.”

You can’t expect this sort of balanced and carefully calibrated approach from a passive “robo-advisor.” During a market downturn, passive investing results in automatic losses.

Many traders follow the lead of the greatest investors, especially Warren Buffett and his Berkshire Hathaway (NYSE: BRK-A). Buffett once famously said: “Be fearful when others are greedy and greedy when others are fearful.” Does that sound like a “passive” stance to you?

The takeaway: Don’t put your portfolio on automatic pilot. Be sure to perform regular performance reviews of your investments and place performance in the wider context of your long-term policies as well as overall market conditions. And continue to follow our advice. We’ll be with you, every step of the way.

Care to weigh in on the debate between passive and active investing, or any other topic? Send me an email: mailbag@investingdaily.com — John Persinos

Profits you can schedule…

Jim Fink, chief investment strategist of Options for Income, has created a proprietary method for making profits that combines passive with active investing. It’s a trading system that’s just like a “profit calendar.”

Jim schedules trades that you make on a weekly basis. As he explains:

“My goal in developing this approach was to produce consistent income on a weekly basis, unlike the quarterly dividends most investors are used to. I’ve found that those longer time periods aren’t a frequent enough source of cash for a lot of investors.”

Jim’s profit calendar allows you to actually schedule, to the day, gains like $1,100… $1,550… and $2,300. Every single week.

These payouts can range in value from $1,150 to $2,800, but generally average out to $1,692.50. Unlike buy and hold strategies most people use, this approach is virtually immune to what the overall stock market is doing over long stretches.

Editors Note: Jim Fink recently recorded a short presentation that explains the secrets behind his investing technique. This presentation is must-see viewing for any serious investor. Click here to watch it now.