Top-Down vs.

Bottom-Up: An Overview

Top-down and bottom-up approaches are methods used to analyze and choose securities.
However, the terms also appear in many other areas of business, finance, investing, and
economics. While the two schemes are common terms, many investors get them confused or don't
fully understand the differences between the approaches.

Each approach can be quite simple—the top-down approach goes from the general to the specific,
and the bottom-up approach begins at the specific and moves to the general. These methods are
possible approaches for a wide range of endeavors, such as goal setting, budgeting, and
forecasting. In the financial world, analysts or whole companies may be tasked with focusing on
one over the other, so understanding the nuances of both is important.

KEY TAKEAWAYS

 Top-down usually encompasses a vast universe of macro variables while bottom-up is more
narrowly focused.
 Top-down investing strategies typically focus on exploiting opportunities that follow
market cycles.
 Bottom-up approaches start with local or company-specific variables and then expand
outward.
 Fundamental analysis is an example of a bottom-up investment approach.
 While top-down and bottom-up are distinctly different, they are often used in conjunction
with one another.

Top-Down

Top-down analysis generally refers to using comprehensive factors as a basis for decision-

making. The top-down approach seeks to identify the big picture and all of its components. These
components are usually the driving force for the end goal.

Top-down is commonly associated with the word "macro" or macroeconomics. Macroeconomics

itself is an area of economics that looks at the biggest factors affecting the economy as a whole.
These factors often include things like the federal funds rate, unemployment rates, global and
country-specific gross domestic product, and inflation rates.

An analyst seeking a top-down perspective wants to look at how systematic factors affect an
outcome. In corporate finance, this can mean understanding how big-picture trends are affecting
the entire industry. In budgeting, goal setting, and forecasting, the same concept can also apply to
understand and manage the macro factors.
Top-Down Investing

In the investing world, top-down investors or investment strategies focus on the macroeconomic
environment and cycle. These types of investors usually want to balance consumer
discretionary investing against staples depending on the current economy. Historically,
discretionary stocks are known to follow economic cycles, with consumers buying more
discretionary goods and services in expansions and less in contractions.

Consumer staples tend to offer viable investment opportunities through all types of economic
cycles since they include goods and services that remain in demand regardless of the economy’s
movement. When an economy is expanding, discretionary overweight can be relied on to produce
returns. Alternatively, when an economy is contracting or in a recession, top-down investors
usually overweight safe havens like consumer staples.

Investment management firms and investment managers can focus an entire investment strategy
on top-down management that identifies investment trading opportunities purely based on top-
down macroeconomic variables. These funds can have a global or domestic focus, which also
increases the complexity of the scope.

Typically, these funds are called macro funds. They make portfolio decisions by looking at
global, then country-level economics. They further refine the view to a particular sector, and then
to the individual companies within that sector.

 
Top-down investing strategies typically focus on profiting from opportunities that follow market
cycles while bottom-up approaches are more fundamental in nature.

Bottom-Up

The bottom-up analysis takes a completely different approach. Generally, the bottom-up approach

focuses its analysis on specific characteristics and micro attributes of an individual stock. In
bottom-up investing concentration is on business-by-business or sector-by-sector fundamentals.
This analysis seeks to identify profitable opportunities through the idiosyncrasies of a company’s
attributes and its valuations in comparison to the market.

Bottom-up investing begins its research at the company level but does not stop there. These
analyses weigh company fundamentals heavily but also look at the sector,
and microeconomic factors as well. As such, bottom-up investing can be somewhat broad across
an entire industry or laser-focused on identifying key attributes.

Bottom-Up Investors
Most often, bottom-up investors are buy-and-hold investors who have a deep understanding of a
company's fundamentals. Fund managers may also use a bottom-up methodology.

For example, a portfolio team may be tasked with a bottom-up investing approach within a
specified sector like technology. They are required to find the best investments using a
fundamental approach that identifies the companies with the best fundamental ratios or industry-
leading attributes. They would then investigate those stocks in regard to macro and global
influences.

Metric-focused smart-beta index funds are another example of bottom-up investing. Funds like

the AAM S&P 500 High Dividend Value ETF (SPDV) and the Schwab Fundamental U.S. Large
Company Index ETF (FNDX) focus on specific fundamental bottom-up attributes that are
expected to be key performance drivers.12

When To Use Both Approaches

Generally, while top-down and bottom-up can be very distinctly different both are often used in
all types of financial approaches like checks and balances. For example, while a top-down
investment fund might primarily focus on investing according to macro trends, it will still look at
the fundamentals of its investments before making an investing decision.

Vice versa, while a bottom-up approach focuses on the fundamentals of investments, investors
still want to consider systematic effects on individual holdings before making a decision.

What Is the Main Difference Between a Top-Down and Bottom-Up Approach?

A top-down approach starts with the broader economy, analyzes the macroeconomic factors,

and targets specific industries that perform well against the economic backdrop. From there,
the top-down investor selects companies within the industry. A bottom-up approach, on the other
hand, looks at the fundamental and qualitative metrics of multiple companies and picks the
company with the best prospects for the future—the more microeconomic factors. Both
approaches are valid and should be considered when designing a balanced investment portfolio.

Which Is Easier: Top-Down or Bottom Up Investing?

Top-down investing is often easier for new investors who are less experienced at reading a
company's financial statements and for those who don't have the time to analyze those financials.

What Is a Limitation of a Top-Down Approach?

A top-down approach is more generalized, and so may miss out on a number of potentially good
opportunities by eliminating specific companies that don't fall into its criteria.

The Bottom Line

Top-down analysis begins at the macro level, looking at things like national economic data (e.g.,
GDP or unemployment) and then homing in on more micro variables. A bottom-up approach is
the opposite, beginning micro (e.g. looking at a single company's financial statements) and then
broadening out. In the end, there is no single best approach to investing, and every approach has
its own pros and cons. A robust strategy is to employ features from both top-down and bottom-up
together.

https://www.investopedia.com/articles/investing/030116/topdown-vs-bottomup.asp

What is Top-Down Approach

In simple terms, a top-down approach is an investment strategy that selects various sectors or
industries and tries to achieve a balance in an investment portfolio. The top-down approach
analyzes the risk by aggregating the impact of internal operational failures. It measures the
variances in the economic variables that are not explained by external macroeconomic factors. As
such, this approach is simple and not data-intensive. The top-down approach relies mainly on
historical data. This approach is opposite to the bottom-up approach.

How the Top-Down Approach Works?

The top-down approach, also known as the "top-down design" or "stepwise refinement," is a
method of problem-solving that starts with an overview of the problem and divides it into smaller
sub-problems. It involves breaking down a complex system into smaller, more manageable
components and solving each component individually, ultimately leading to the solution of the
overall problem. This approach is helpful in software development, project management, and other
fields where complex tasks must be decomposed into smaller, more manageable parts.

When to Use the Top-Down Approach?

The top-down approach is best used when:

 The problem is complex and needs to be broken down into smaller, manageable parts.
 There is a need to understand the big picture before diving into details.
 A clear understanding of the end goal is required before starting the project.
 The solution can be divided into smaller subproblems that can be solved independently.
 The problem has multiple potential solutions, and a top-down approach can help prioritize and
evaluate them.

Top-Down Approach Advantages and Disadvantages 

Advantages

 Easy to understand and implement.

 Provides clear objectives and expectations.
 Supports effective allocation of resources.

Disadvantages:

 Inflexible to change
 Limited to pre-determined solutions.
 Can lead to missed opportunities or inefficiencies.
 Can result in lower motivation and participation from lower-level employees.

What Companies Use the Top-Down Approach?

Many companies use the top-down approach in their management and decision-making processes,

including:
1. IBM
2. Microsoft
3. Google
4. Apple
5. Amazon
6. GE
7. Intel
8. JPMorgan Chase
9. Goldman Sachs
10.Procter & Gamble.

Top-Down Approach Examples 

 Company Management Structure: A CEO creates a strategic plan for the company and delegates
tasks to department managers, who in turn delegate to their subordinates.
 Software Development: A software architect creates a high-level design, which is then divided
into smaller tasks for software engineers to implement.

Bottom-Up Approach
A bottom-up approach, on the other hand, is an investment strategy that depends on the selection
of individual stocks. It observes the performance and management of companies and not general
economic trends. The bottom-up approach analyzes individual risk in the process by using
mathematical models and is thus data-intensive. This method does not rely on historical data. It is
a forward-looking approach unlike the top-down model, which is backard-looking.

How the Bottom-Up Approach Works?

The bottom-up approach works by starting with individual components and building up to the
larger system. This approach is characterized by:

 Breaking down a large problem or project into smaller, more manageable tasks
 Starting with the details and working toward the bigger picture
 Emphasizing the importance of getting each individual task or component right before moving
on to the next
 Encouraging collaboration and communication between teams working on different components
to ensure overall consistency and coherence
 Focusing on the implementation and execution of each individual task, rather than abstract
planning or decision-making.

When to Use the Bottom-Up Approach?

The bottom-up approach can be useful in situations where:

 The problem or project is too complex to be fully understood at the outset

 There is a need to build a foundation of detailed knowledge before moving on to higher-level
work
 It's unclear how the different components of a problem or project fit together
 There is a need to experiment and iterate on different components to find the best solution.

Bottom-Up Approach Advantages and Disadvantages 

Advantages:

 Flexibility: Bottom-up approach allows for changes to be made at any stage of the process.
 Empowerment: It gives individuals and smaller groups the power to make decisions.
 Robustness: This approach can result in more robust solutions, as each component can be
thoroughly tested and debugged.

Disadvantages:

 Slow Progress: The bottom-up approach can be slow, as each component must be completed
before moving on to the next.
 Lack of coherence: The final solution may lack coherence, as it is assembled from individual
parts.
 Difficulty in managing complex projects: This approach can be difficult to manage for complex
projects with many components.

What Companies Use a Bottom-up Approach?

Many companies use the bottom-up approach in their management and decision-making processes,
including:

1. Toyota
2. Hyundai
3. Ford
4. Volkswagen
5. Samsung
6. Nokia
7. Dell
8. Hewlett-Packard
9. Cisco Systems
10.Oracle
Bottom-Up Approach Examples

 Cooking a Meal: A chef starts with individual ingredients and combines them to create a dish.
 Assembly Line: Workers assemble individual parts to create a final product.
 Problem-Solving: Breaking down a large problem into smaller parts and solving each one
individually.

Difference Between Top-Down and Bottom-Up Approach 

The main differences between the top-down and bottom-up approaches are:

 Starting Point: The top-down approach starts with a high-level understanding of the problem,
while the bottom-up approach starts with individual components.
 Focus: The top-down approach focuses on high-level planning and decision-making, while the
bottom-up approach focuses on the implementation and execution of individual tasks.
 Prioritization: The top-down approach prioritizes the end goal and the desired outcome, while
the bottom-up approach prioritizes the details and getting each individual component right.
 Control: The top-down approach often involves central control and decision-making, while the
bottom-up approach empowers individuals and teams to make decisions and drive the process
forward.
 Communication: The top-down approach relies on communication from the top to the bottom,
while the bottom-up approach emphasizes collaboration and communication between different
teams working on different components.
 Flexibility: The top-down approach can be less flexible, as decisions are made at a high level
and the process is more structured, while the bottom-up approach allows for more adaptability
and iteration based on feedback and changing requirements.
 Risk: The top-down approach can be riskier, as decisions are made at a high level and may not
account for all the details and complexities of the problem, while the bottom-up approach
addresses risks by focusing on the details and iterating based on feedback.
https://www.simplilearn.com/top-down-approach-vs-bottom-up-approach-article
Active portfolio management strategy: An overview
An active portfolio management strategy involves buying and selling of investments with an
aim to outperform a broad market index. Generally, investors who adopt this approach enlist
the help of a professional portfolio manager, who uses experience and expertise to
strategically choose the options to invest in. In other words, such a portfolio manager is
much like a hands-on coach, who is constantly monitoring the team and making changes
when needed.

An active portfolio management strategy involves conducting in-depth research into the

companies, forecasting of market trends and closely following the changes in the economy
and political landscape. The data that is collected from these activities is then put to use to
purchase and sell investments. 

Since the active portfolio management strategy involves the use of comprehensive data and
extensive analysis, it is widely believed that this strategy would generate returns that are
higher than the market. Equity mutual funds are prime examples where an active portfolio
management strategy is employed.    

Characteristics and advantages of active portfolio management strategy

Now that you know what this strategy is, let’s take a look at some of the characteristics and
advantages it offers investors like you. 

o It provides you with an opportunity to outperform the market.

o It gives you the ability to employ various sub-strategies and techniques.
o Since investments are bought and sold regularly, this strategy has a high portfolio
turnover.

 
Passive portfolio management strategy - an overview
A passive portfolio management strategy is an approach that aims to mimic the performance
of a broad market index. It involves constructing a portfolio and constituting it with the same
investments as in a broad market index. Here, the role of a professional portfolio manager is
very limited. Compared to active portfolio management, this strategy is far more relaxed and
laid-back. 

Remember reading about efficient market hypothesis in the previous module? The passive
portfolio management strategy is based on this theory. It assumes that the market factors in
all the available information and that no amount of analysis or research can help you gain an
edge. Therefore, this strategy does not involve the use of extensive analysis, research, or
comprehensive data.

Since this strategy employs a buy and hold approach, it is the perfect choice for long-term
investors looking to replicate the returns generated by the market. Index funds are ideal
examples of a passive portfolio management strategy.    

Characteristics and advantages of passive portfolio management strategy

Here’s a quick glimpse of some of the distinctive characteristics and advantages offered by
a passive portfolio management strategy. 

o It provides you with the ability to match the returns of the market.
o The costs associated with passive portfolio management strategy are very low.
o Passive portfolio management gives you a high level of transparency with respect to
the portfolio’s constituents.  
o Since the stocks are not sold immediately after they’re bought, the portfolio turnover is
little to none.

o Discretionary Portfolio Management

The fund manager has total control over their client's investment choices when using a
discretionary portfolio management technique. All of their clients' purchase and sell decisions
are made by the discretionary manager, who uses whichever strategy they feel is best. This
kind of strategy can only be provided by those with extensive investing knowledge and
experience. Discretionary managers' clients feel comfortable committing their investment
decisions to an expert.

The main benefit of discretionary investing is that you delegate all of your financial choices to
a professional. This makes things much easier, particularly if you agree with your manager's
purchase and sell recommendations. Discretionary accounts aren't for you if you like to have
greater control over your money. If cost is a consideration, discretionary accounts may be
more costly since discretionary managers demand greater fees for their services. Using our
Dividend Assistant feature, you can keep track of how your payout income changes when
stocks raise or reduce their dividend.

o Non-discretionary Portfolio Management

A financial advisor, in essence, is a non-discretionary portfolio manager. They will explain the
advantages and disadvantages of investing in a certain market or strategy, but they will not
carry it out without your approval. The main distinction between a non-discretionary and a
discretionary strategy is this. The main advantage of non-discretionary investing is that it
allows you to consult with a financial professional without giving up control over your
investments. The main disadvantage is the necessity to swiftly adjust a portfolio's
concentration in response to changing market circumstances. It might cost you money if your
manager needs your consent before purchasing or selling a specific item.

Wrapping up
That brings our introduction to these two portfolio management strategies to a close. If you’d
like to fine-tune your portfolio management skills, head to the next chapter to find out more
about the errors that you need to avoid.

A quick recap
o A portfolio management strategy essentially involves the following elements: picking
the right investment options for your individual investor profile and monitoring their
performance to ensure that they meet your financial objectives.
o There are two main portfolio management strategies that you should know about:
active and passive.
o An active portfolio management strategy involves buying and selling of investments
with an aim to outperform a broad market index.
o It also involves conducting in-depth research into the companies, forecasting of market
trends and closely following the changes in the economy and political landscape. 
o A passive portfolio management strategy is an approach that aims to mimic the
performance of a broad market index. It involves constructing a portfolio and
constituting it with the same investments as in a broad market index.

https://smartmoney.angelone.in/chapter/portfolio-management-types/

Passive vs. Active Portfolio Management: An Overview

Investors have two main investment strategies that can be used to generate a return on
their investment accounts: active portfolio management and passive portfolio management.

 Active portfolio management focuses on outperforming the market in comparison to a

specific benchmark such as the Standard & Poor's 500 Index.
 Passive portfolio management mimics the investment holdings of a particular index in
order to achieve similar results.
As the names imply, active portfolio management usually involves more frequent trades
than passive management.

An investor may use a portfolio manager to carry out either strategy, or may adopt either
approach as an independent investor.

KEY TAKEAWAYS

 Active management requires frequent buying and selling in an effort to outperform a

specific benchmark or index.
 Passive management replicates a specific benchmark or index in order to match its
performance.
 Active management portfolios strive for superior returns but take greater risks and
entail larger fees.

Active Portfolio Management

The investor who follows an active portfolio management strategy buys and sells stocks in
an attempt to outperform a specific index, such as the Standard & Poor's 500 Index or the
Russell 1000 Index.

An actively managed investment fund has an individual portfolio manager, co-managers, or

a team of managers all making investment decisions for the fund. The success of the fund
depends on in-depth research, market forecasting, and the expertise of the management
team.

Portfolio managers engaged in active investing follow market trends, shifts in the economy,
changes to the political landscape, and any other factors that may affect specific
companies. This data is used to time the purchase or sale of assets.

Proponents of active management claim that these processes will result in higher returns
than can be achieved by simply mimicking the stocks listed on an index.

Since the objective of a portfolio manager in an actively managed fund is to beat the market,
this strategy requires taking on greater market risk than is required for passive portfolio
management.

 
Passive portfolio management is also known as index fund management.

Passive Portfolio Management

Passive portfolio management can be referred to as index fund management. This is
because a passive portfolio is typically designed to parallel the returns of a particular market
index or benchmark as closely as possible. For example, each stock listed on an index is
weighted. That is, it represents a percentage of the index that is commensurate with its size
and influence in the real world. The creator of an index portfolio will use the same weights.

The purpose of passive portfolio management is to generate a return that is the same as the
chosen index.

A passive strategy does not have a management team making investment decisions and
can be structured as an exchange-traded fund (ETF), a mutual fund, or a unit investment
trust (UIT).

Index funds are branded as passively managed rather than unmanaged because each has
a portfolio manager who is in charge of replicating the index. Because this investment
strategy is not proactive, the management fees assessed on passive portfolios or funds are
often far lower than active management strategies.

https://www.investopedia.com/ask/answers/040315/what-difference-between-passive-and-active-
portfolio-management.asp#:~:text=Active%20portfolio%20management%20focuses%20on,order
%20to%20achieve%20similar%20results.