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Active money management or buy and hold?

With so much volatility in the stock market, investors saving for retirement must decide what investment approach may work best over the long term. Some market players question the wisdom of a "buy and hold" investment strategy, embracing active management instead.

The debate is not new, but perhaps it's become more heated after the roller coaster ride of the past decade.

Before making fundamental changes to your investment approach, here's what you need to know about active money management versus buy and hold.

The argument for active management

Supporters of active money management say that buy and hold is not a good long-term investment strategy for the small investor. They note that the most recent decade was not the only period of time that stocks -- the assets favored in buy-and-hold portfolios -- underperformed other, less risky, assets.

For example, from 1966 to 1982, the S&P 500 produced no real return (meaning it did not keep up with inflation), underperforming one-month Treasury bills by 0.2 percent per year. From 1966 to 1988, U.S. large growth stocks consistently underperformed one-month CDs.

"There's really nothing new about buy and hold being a terrible investment strategy," says Ken Solow, chief investment officer and senior partner of Pinnacle Advisory Group and author of the book "Buy and Hold Is Dead (Again)."

"The underlying theoretical proposition for buy-and-hold investing, which is the idea that stocks outperform bonds and cash over long periods of time because markets are efficient ... all of that has been disproved. Markets have shown that they aren't efficient, investors aren't rational, and ... when you buy stocks that have become expensive, you have minimum hope of achieving expected average returns."

Today's investors can no longer afford to put large sums of money into expensive assets, he says. This environment calls for tactical money management, especially if we are in the cyclical, long-term bear market that Solow fears has already begun.

At the core of his money management strategy is tactical asset allocation, one of many types of active management strategies. This one involves a diversified portfolio that includes multiple asset classes with percentage weightings that change as the market moves or as the perception of the market's risk changes. This portfolio can change from day to day, and what it consists of one week may not be what it consists of the next.

"Asset classes are evaluated to ensure that the portfolio is diversified and then they're assessed for their relative risk. ... If the risk is lower in one asset class than another, we might add to the lower-risk asset classes and take profits out of the higher-risk ones ... to tactically manage risk," he says.

Portfolio assets, Solow says, should change as market valuations change, the market cycle changes, or investor technicals and momentum change.

Unfortunately, finding a qualified investment manager who understands and successfully practices tactical asset allocation is not easy. Morningstar doesn't have a category for tactical asset allocation funds, so there's no way to evaluate how they perform relative to their peers.

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