If you’ve decided to invest your money in the markets, one of the first decisions you’ll have to make is what strategy you’ll use while choosing investments. To build the best portfolio for your financial goals, your risk tolerance, your initial capital, as well as your time horizon, you’ll need to decide, broadly speaking, between “active” investing and “passive” investing.
“Active” trading, as the name implies, is the more aggressive investment approach, being hands-on and generally more short-term orientated. “Passive” investing, on the other hand, refers to more of a “buy-and-hold” strategy and has a longer-term outlook.
Passive investing is attracting an increasing number of investors looking for a more balanced approach to the broad markets, while also limiting buying and selling activity. Passive investing is set to be even more popular than active investing this year in the United States, as .
What does active investing really mean?
In portfolio management, an active investing strategy relies on a hands-on approach, with someone in the role of a portfolio manager picking the assets and deciding when to invest, seeking to outperform the average market return.
It’s thus a short-term approach, as it’s all about taking full advantage of short-term price changes. For this reason, this investment technique is quite aggressive and requires deep fundamental and/or technical analysis and research to pick up the right assets to invest in at the right time.
As this method of investment involves a high volume of transactions (and therefore fees), it tends to have quite high operating costs.
What involves being a passive investor?
While active investing is all about investing in different assets based on research and analysis, passive investing is more about matching the performance of a selected market.
It focuses on relative returns via financial vehicles like index funds which gather all the securities of the targeted market. This type of fund reflects the benchmark index it represents, and thus offers broad market exposure – and as you might guess, there is an index fund for nearly every market!
Because a buy-and-hold strategy doesn’t involve stock picking and market timing, there are lower fees and expenses associated with it than with active investing. It is also a less risky approach to investing, as it ignores short-term market fluctuations.
Active vs. Passive Investing: What’s best?
Active investing has the potential to earn higher returns than passive investing, as it is a more risky and aggressive method of investment, one that looks to take advantage of each little price inefficiency in the markets. It’s a very flexible investment method, as you can use short-selling, derivatives, hedging, arbitrage, etc. This type of investment method can be expensive though, as there are more buying/selling movements. Taxes are also high, as profits are often heavily taxed (capital gains).
Passive investing, on the other hand, isn’t aiming at taking advantage of short-term market movements, as it follows a long-term objective. It isn’t about timing the market or beating it, it’s about following the long-term changes of markets thanks to passive fund investments while saving time on research and analysis. Thus, passive investing requires less decision making than active investing. It is also generally more .
While active investment strategies might have benefited investors in more volatile investing climates, passive strategies are gaining momentum, as they tend to outperform other types of market conditions over the long-term.
More and more investors believe that a mix of both approaches is the best way to get higher returns. But in the end, when you decide a way to build your wealth through investment, it really comes down to a personal choice based on your trading personality, your priorities, your goals, and your timeline.