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The Third Wave

By David Kahn and Alexander Hart

Passive, ETF based portfolio strategies may be supplanted by a New Paradigm that offers a superior combination of cost, tax-efficiency and customization.

In the constantly evolving landscape of personal finance, one trend has persisted – the increasing popularity of passive investing.  What started as a simple concept championed by the late John Bogle of Vanguard has become a tidal wave of enthusiasm across virtually every asset class. Passive instruments (index-based mutual funds and exchange-traded funds, or ETFs) now represent the core building blocks of many “modern” portfolios.

The basic premise behind passive investing is the somewhat antithetical notion that being average is a good thing.  While many investors assume a Lake Wobegon set of rose-colored glasses, a bevy of academic research confirms that being average (matching the performance of an index) actually results in performance comfortably above the median.    This paper provides a statistical backdrop of the dominance of passive investing, illustrates how passive tools have become the bedrock of a new method of portfolio construction for taxable investors, and then offers an alternative approach that may provide investors with even better outcomes over time.

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