Active versus Passive Investing
There are two ways that you can manage your portfolio of investments – active or passive investing. Investors and investment managers will often strongly favour one method over the other and it can often turn into a heated debate as to which method is better. An investor may use these methods personally or use an investment manager.
Active Investing
Active investing requires a hands-on approach and involves frequent buying and selling of investments – hence the name active. It focuses on outperforming the market and trying to take advantage of short-term price fluctuations. Active investing involves in-depth research on investments, review of the political environment and constant monitoring of the market and trades.
Passive Investing
Passive investing aims to maximise returns by minimizing buying and selling of investments. It is a long-term strategy with minimal trading and is designed to generate a return that matches a specific benchmark or index – such as the NZX 50 (the largest 50 stocks on the NZ stock market). This method is not proactive and requires a buy-and-hold mentality. The key assumption with this strategy is that the market will return positive results over time. Passive investment funds can sometimes be called “index funds”.
Advantage and Disadvantages of Active and Passive Investing
Because there is less buying and selling of investments, passive investing can have lower fees and operating expenses than active investing.
Active investing allows you to buy any investments you think might outperform the market so you have greater flexibility than passive investing which will normally follow a specific index.
Passive investing will normally never beat the market – the aim is to match the market. The goal with active investing is to beat the market and when it succeeds it can mean much higher returns. There is much debate as to which strategy actually does achieve the highest returns.
Because active investing aims for superior returns there is greater risk. The rewards can be great but the losses can be large if it goes wrong. This must be taken into account when reviewing each strategy.
In the end the decision really comes down to your personal priorities, your risk profile, timelines and goals.
Happy investing.
James