When considering an investment strategy, we are faced with the situation of deciding whether we want to actively or passively manage our investments. What are the differences between one and the other? Which is the most recommended? Here’s a breakdown of how active and passive investors typically differ.
- What is Active Investing?
Active investing refers to an investment strategy that involves ongoing buying and selling activity by the investor. It aims to exceed the stock market’s average returns and take full advantage of short-term price fluctuations. Active investors tend to keenly watch the market, make trades appropriately and try to beat that market.
Advantages
As active investors tend to try to beat the market, when they succeed it may translate to higher than average returns. They aren’t required to follow a specific index, instead they can buy those “diamond in the rough” stocks they believe they’ve found and they’re also able to exit specific stocks or sectors when the risks become too big.
Successful active investing requires high level of confidence when making investment decisions and being right more often than wrong.
Disadvantages
Active investing requires a lot of time and knowledge that is not available to most investors. It requires time for stock analysis and keeping up with market movements. In addition, it also involves the expertise to determine where and when that price will change.
Therefore, engaging with an active fund manager is ideal in order to oversee the investments. However, you have to be aware that by using a professional fund manager you are placing your trust in them and have to accept there is a possibility they could misjudge the market and choose under-performing stocks. Moreover, this professional implies a cost for you.
- What is Passive Investing?
Passive investing is based on buying and maintaining the investment over long periods of time, whereas active investing tends to chase shorter term gains. Passive investors have lower risk tolerance and just track a market index. It is a ‘set and forget’ approach.
Advantages
Passive investing requires limited effort and knowledge available to anyone. Taking this approach can be a more affordable way to access the market, as it can exclude the fees that come with an active fund manager. Also, passive investors generally have complete transparency over their investments. Lastly, it doesn’t typically result in a massive capital gains tax for the year.
Disadvantage
On the other side of the coin, passive funds are limited to a specific index or predetermined set of investments with little to no variance; thus, investors are locked into those holdings, no matter what happens in the market. Moreover, as passive funds are not focused on beating the market, they will unlikely post big returns unless the market itself booms.
- Making Strategic Choices
For most people, there’s a time and a place for both active and passive investing over a lifetime of saving for major milestones like retirement. In the end, it comes down to personal preference and what suits your investment goals.
If time is on your side and you don’t need to access your funds for a while, you may want to consider passive investing. However, if time is of the essence and you prefer a more hands-on approach, active investing might be worth exploring.
Source:
Canstar, 2018: https://www.canstar.com.au/investor-hub/active-vs-passive-investing/
Investopedia, 2018: https://www.investopedia.com/news/active-vs-passive-investing/
