The mainstream advice in personal finance for years has been that passive investing is the undisputed champion for the average investor. Financial media and best-selling books have beaten the drum for low-cost index funds.
For the average investor, the advice makes sense. The strategy is simple, cheap, and has a proven track record of delivering market-average returns. But if you’re a pre-retiree, is “average” good enough?
This is the time for robust retirement planning, and that means taking a closer look at the investing styles that can build and protect wealth in the key years leading up to and during retirement.
The New Industrial Revolution: AI and Active Investing
We are currently in the early stages of a technological revolution driven by artificial intelligence and other disruptive technologies. This isn’t just another market trend; it’s a fundamental shift that will create clear winners and losers across every industry. For pre-retirees, navigating this transformation is critical, and it highlights a potential weakness in a purely passive strategy.
Market indexes like the S&P 500 are, by design, slow to adapt. They are weighted by market capitalization, meaning they are dominated by yesterday’s winners. As new, innovative companies emerge and legacy giants fail to adapt to the AI revolution, a passive index fund will force you to hold onto those declining companies long after their prospects have faded. You are essentially locked into owning the past, even as the future is rapidly taking shape.
This is where active management becomes pivotal in 2025. A skilled portfolio manager can:
- Identify the Innovators: Actively research and invest in the emerging leaders of the AI era before they become household names and dominate the indexes.
- Avoid the Dinosaurs: Recognize and sell positions in companies that are being disrupted or are failing to innovate, protecting your capital from predictable declines.
The Passive Promise vs. Reality
Passive index exchange-traded funds (ETFs) are designed to track a specific market index, such as the S&P 500. Their appeal lies in their low costs, simplicity, and the promise of delivering market-average returns without the need for active management. What you get with this strategy is very broad market exposure and it eliminates the risk of underperforming a benchmark due to poor stock selection. But it also means accepting whatever returns the market delivers, including during downturns.
Passive investing aims for market-average returns. Active management, particularly active stock portfolio management, gives you the the ability to outperform. A skilled portfolio manager or registered investment advisor can identify mispriced assets, avoid overvalued ones, and adapt to changing market conditions. This proactive approach allows for strategic adjustments that passive funds simply can’t make.
Beyond Average: The Power of Selection
Passive investing means owning everything in an index, including the laggards. This can be a significant drawback, especially for those focused on wealth preservation. In contrast, active stock selection allows a portfolio manager to build concentrated portfolios of high-conviction stocks. This targeted approach means you’re not forced to hold declining assets.
The dot-com bubble collapse of 2000-2002 is a classic example. During this period, active funds declined by only -1.40% compared to passive funds’ -9.43%. This outperformance was largely due to active managers being underweight in the overvalued technology sector, a move a passive fund tracking the S&P 500 could not make.
True Cost of Passive Investing Through an Advisor
Passive index ETFs are often praised for their low internal expense ratios. But when you hire an advisor who primarily uses a passive strategy, you must consider the total cost: the ETF fees plus the advisory fee—often around 1% annually.
You are paying a premium for a strategy that, by its nature, cannot adapt. Unlike active management, which can dynamically sell declining assets, passive ETFs must hold all securities in their benchmark, regardless of performance. This leaves your portfolio exposed to struggling companies.
Essentially, you may be paying a 1% advisory fee for a strategy that doesn’t include active risk management or custom portfolio management. In contrast, a truly active investment advisor can respond to market shifts by selling declining assets, harvesting tax losses, and reallocating capital to more promising opportunities. This proactive approach to wealth management aims to maximize after-tax returns and manage risk dynamically—benefits a purely passive strategy with a flat advisory fee may not deliver.
As a fiduciary and RIA, our job is to look for these opportunities for you.
Ready to move beyond the standard advisor playbook?
At Paraiba Wealth, our focus is on building actively managed portfolios—a strategy designed for greater control, tax efficiency, and tailored to you. If you’re ready to see what this looks like, book a no-obligation initial call today.