1. What is investment management (both what it is overall and as a service that advisors provide)?

When done correctly, investment management is a holistic process that analyzes the investor's financial situation, needs, goals, and even ethics. A top-down approach typically begins with asset allocation and ends with security selection. The middle layers can vary widely between managers and may include sector rotation, market timing, hedging strategies, geographic considerations, or ethical exclusions. A bottom-up approach begins with security selection. At Magnifina, we utilize a hybrid approach.

While some investors can manage their own portfolios, many prefer to utilize a professional advisor. Good investing can require immense amount of financial knowledge, time spent researching, and emotional control. Advisors help clients achieve favorable outcomes while saving them all that time and hassle. I like to describe investment advisory as 'autopilot for your portfolio'. Clients always have the ability to override it.

2. Could you describe some of the key components in investment management, such as asset allocation, monitoring, rebalancing, etc.?

-- Asset allocation is determining how much of a portfolio to invest in broad asset classes. When aggregated, different kinds of securities produce different risk and return profiles. Asset allocation looks at long-term averages and correlations to determine how much of a portfolio should be invested in each asset class. It is very often dynamic and changes as an investor's needs change.

-- Security selection depends heavily on the investment approach. For passive index investing, selection focuses on fees as the differentiator because multiple funds provide roughly the same risk exposure. But for classical investors, security selection is the most important phase of investing. When selecting individual stocks, there are myriad factors to consider. While usually starting with accounting statements, not all factors are quantitative in nature. Management's temperament can be just as important, and is of course impossible to measure objectively.

-- Rebalancing is when trades are made to bring a portfolio's actual holdings back to its targets. Because investments grow at different rates, portfolios will become imbalanced over time. Generally this means selling excess stocks (which drive returns) and buying bonds (which provide safety). Frequent rebalancing can reduce returns. I view it as trimming your flowers and watering your weeds. (n.b. this metaphor is attributed to Peter Lynch, who was talking about individual stocks rather than asset classes).

-- Tax loss harvesting is taking losses and reallocating to similar investments. The capital losses can be used to offset future gains. This is most commonly done right before the end of the calendar year. For ETFs, there are so many alternatives that investors can find essentially the same risk exposure. For individual stocks, there are often natural duopolies that can provide very close machines. E.g. Mastercard and Visa.

3. Could you explain the two common investment management approaches (active vs. passive) and the benefits/downsides of each?

Passive investing focuses on long-term asset classes rather than individual securities or market timing. The thinking is that because markets are efficient, it is safer to settle for an average market return rather than aiming for superior performance. The logic is sound-- after all, not everyone can be above average. Investors typically select index funds, which are diversified across hundreds of individual stocks. This level of diversity minimizes the risk of a catastrophic loss tied to just a few stocks.

It is critical to note that while passive investing aims to minimize risk through diversity, it can sometimes backfire. Due to how they are calculated, cap-weighted indices have become concentrated in their biggest constituents. Earlier this year, around 40% of the S&P 500 was concentrated into just 10 stocks. Combining this hidden concentration risk with historically high valuations, passive investing's goal of safety may be an illusion.

The alternative approach is active investing. Although commonly associated with market timing, active investing covers a wide range of approaches. Before funds, all of investing would be considered active by today's standards. Simply selecting a portfolio of individual stocks and bonds involves considerably more discretion than passive approaches. It's strange to see that the fundamentals of investing are considered outmoded by many within this industry.

Active investing performance is much more variable than common passive strategies. Of course this cuts both ways. Psychologically, the fear of underperforming a simple passive strategy is often stronger than the appeal of outperforming. This is the prevailing view in the industry. But it's worth pointing out that only an active approach can avoid severe market downturns. Passive investors must accept these events.

For the past 15 years, the market has performed extremely well. This environment favors passive investing approaches. Looking forward, I have doubts that the market will continue with the same trajectory. In this case, it will be easier for many active investing approaches to outperform.

Ultimately it's a spectrum. Every strategy falls somewhere between purely passive and purely active. At Magnifina, we also take a hybrid approach by blending a passive allocation and active one.