Active vs Passive: The $1M+ Portfolio Decision

When your portfolio crosses the seven-figure threshold, the active versus passive debate stops being theoretical and starts having real dollar consequences. A 1% difference in fees and performance on a $1.5 million portfolio equals $15,000 annually—enough to fund a decent holiday or contribute significantly to your retirement income.

Yet despite decades of debate, many Australian investors still struggle with this decision. Let me share what the evidence actually shows and how we approach this question with our clients.

The Passive Case: Simple But Powerful

Passive investing through index funds and ETFs has won considerable ground for good reason. The logic is elegant: if most active managers can't beat the market after fees, why pay them to try?

The Australian data supports this. Research consistently shows that the majority of actively managed Australian equity funds underperform the S&P/ASX 200 over rolling five and ten-year periods. When you factor in the fee difference—typically 0.10-0.30% for passive versus 0.80-1.50% for active—the hurdle becomes even steeper.

For a $1.2 million portfolio split between Australian and international equities, choosing passive options could save $10,000 to $15,000 annually in fees alone. Compound that over 20 years, and you're looking at hundreds of thousands of dollars in additional wealth, assuming similar gross returns.

Passive investing also offers simplicity and tax efficiency. Less trading means fewer capital gains events. Lower costs mean more of your money stays invested. It's a compelling proposition, particularly for growth assets like Australian and international shares where market efficiency is relatively high.

Where Active Management Earns Its Keep

However, dismissing active management entirely would be premature, especially for portfolios exceeding $1 million where sophistication can add genuine value.

First, consider Australian small caps. This segment of the market receives less analyst coverage and exhibits greater pricing inefficiencies. Quality active managers with genuine research capabilities have demonstrated more consistent ability to add value here than in large-cap equities. For a portion of your Australian equity allocation, active small-cap exposure may be justified.

Second, fixed income deserves closer attention. While passive bond funds offer low-cost exposure, skilled active bond managers can add value through duration management, credit selection, and tactical positioning—particularly important as interest rates fluctuate and credit spreads widen or narrow. With $300,000 to $500,000 allocated to fixed income in a typical $1.5 million portfolio, the right active manager might add 0.50-1.00% annually after fees.

Third, alternative investments and absolute return strategies simply don't have passive equivalents. Strategies targeting uncorrelated returns—such as market-neutral funds, merger arbitrage, or certain hedge fund approaches—can improve portfolio risk-adjusted returns. These aren't about beating the market; they're about providing different return streams that enhance overall portfolio resilience.

The Real Question: Strategic vs Tactical

For most seven-figure portfolios, the answer isn't binary. It's about strategic allocation.

A thoughtful approach might include passive exposure for core market holdings—say, 60-70% of your growth assets through low-cost Australian and international index funds. This captures broad market returns efficiently and keeps costs contained.

The remaining allocation can incorporate active strategies where evidence suggests potential for value-add: selected active managers in Australian small caps, tactical bond management, and perhaps modest alternative strategy exposure for diversification.

This isn't about hedging your bets or sitting on the fence. It's about being evidence-based and pragmatic. Use passive where markets are efficient and active management adds little value. Consider active where genuine skill can overcome fees and add to returns or reduce risk in ways passive strategies cannot.

The Australian Context Matters

For Australian investors, several local factors influence this decision:

Franking credits remain valuable, and some active managers demonstrate better ability to harvest franking efficiently, particularly important for retirees drawing income from portfolios.

Market concentration in the ASX 200 means the top ten stocks represent roughly 50% of the index. Passive Australian equity investors get enormous exposure to banks and miners. Active management can provide more balanced sector exposure if that concentration concerns you.

Currency management for international holdings can add value through active decisions, particularly for portfolios exceeding $1 million where hedging costs and benefits become more material.

What This Means For Your Portfolio

If you're managing a portfolio above $1 million, here's a framework to consider:

Review your current fee structure honestly. Calculate exactly what you're paying in percentage and dollar terms across all holdings. Are those fees justified by performance, service, or strategic value?

Evaluate each holding on its merits. Your Australian large-cap active fund that's underperformed for five years probably deserves replacement with a low-cost index option. But that bond fund that's consistently added value through credit selection might justify its higher fee.

Consider your broader circumstances. Time-poor professionals might value the simplicity and reliability of passive investing. Those with more complex situations—business owners, retirees managing sequencing risk, or those with concentrated wealth—might benefit from the tailored approaches active management can provide.

Think about evolution, not revolution. You don't need to overhaul everything immediately. A phased transition over 12-24 months can minimize tax consequences and allow thoughtful implementation.

The Bottom Line

The active versus passive debate becomes less ideological and more practical when significant wealth is at stake. Neither approach is universally superior. The best portfolios typically combine both, using each where it offers genuine advantage.

For your seven-figure portfolio, the goal isn't to win the debate—it's to build the most efficient, appropriate portfolio for your specific circumstances. That requires moving beyond tribe mentality and focusing on evidence, costs, and alignment with your goals.

The $1 million question isn't really "active or passive?" It's "which active strategies, if any, justify their costs within my broader passive framework?" Answer that thoughtfully, and you'll make better decisions with your wealth.

This article provides general information only and does not consider your specific circumstances. Before making investment decisions, consider speaking with a licensed financial adviser.