Active investing, because of its ability to take advantage of short-term stock increases, is often seen as the best way to reap high returns as compared to passive investing, which ignores brief downturns in the market for later gains.
However, the key to making the best investment decisions is to be as informed as possible about both strategies, which this brief guide on the difference between active and passive investing will help you with.
With active investing, a portfolio manager takes an active approach to outperform the average returns of the stock market using deep analysis to predict when a sector or company will experience price fluctuations, which thus alerts them when to enter into or opt-out of a particular investment asset.
In doing so, they are also able to take advantage of short-term price increases,
which many believe enables them to reap the highest returns on stock prices as compared to waiting and selling it in the future when stock prices could fall.
Passive investing, on the other hand, utilizes a buy-and-hold strategy, which enables investors to benefit from a company’s exponential earnings over time via the stock market.
Furthermore, because this type of investing limits the number of purchases and sales within a portfolio, it also provides a cost-effective way to invest, which many people also love.
Active vs. Passive Investing
Active investing advantages:
- It provides the ability to use other strategies to protect against loss, also known as hedging. For instance, some investors use put options or short sales to help shield against risks.
- Active managers are not required to hold specific assets; therefore, it offers greater flexibility.
- It enables investors to get in and out of specific sectors or holdings when risks become too high, which means it is also good for risk management.
Passive investing advantages:
- There’s no portfolio manager analyzing or picking stocks so the fees are low.
- The buy-and-hold strategy does not yield significant annual capital gains – hence, it is more tax-efficient.
- Investors know at all times what indexed investments their portfolio contains so there is greater transparency.
Active investing disadvantages:
- Managers can buy any investment they predict will yield high returns – so there is a more active risk, especially if they’re not successful.
- Fees are higher because it is an actively managed equity fund.
Passive investing disadvantages:
- Passive funds almost never outperform the market so the returns are often small.
- Investors are locked into a specific set of investments – therefore, it can be too limited.
So which investment strategy is best? According to the experts at Money Morning, “while both active and passive investing offer their own sets of advantages and disadvantages, there’s no one-size-fits-all approach to choosing a strategy.” You could even use a combination of both strategies for optimum success, as many investors do.