Passive vs. Active Investing: Which Is The Best?

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    passive vs. active investing

    Which is better, active or passive investing? Anyone familiar with the remote investment community will know that this particular topic is an ongoing debate. And that. The debate has intensified in recent years.

    In reality, the best form of investment depends on your investment goals.

    With that in mind, let’s take a closer look at the details of passive versus active investing. Once you have the information you need, it’s up to you to decide which one will fit your portfolio better.

    Passive vs. active investing

    First things first, it’s important to understand what the terms passive investing and active investing actually mean. Let’s start with the basics.

    What is passive investing?

    Passive investing involves a hands-off approach. As a passive investor, you are likely to invest for the long term. With this, you may not be interested in making regular trades for short term profits. Likewise, don’t try to beat the market with sophisticated investment strategies that require constant portfolio updates.

    Instead, passive investors want to build their investments and leave the rest to the market. They usually invest in index funds that track certain market benchmarks. Essentially, passive investors stick to the idea that time in the market is better than the timing of the market.

    Of course, that doesn’t mean that passive investors ignore their portfolios completely. In fact, regularly rebalancing the portfolio is an important part of any passive investment strategy. However, passive investors are likely to only review their portfolio once a quarter or less.

    What is active investing?

    Active investing involves a more practical approach. With an active investment strategy, an investor or his asset manager constantly monitors the market. As the market fluctuates, the investor looks for ways to improve his portfolio.

    Typically, active investors are preoccupied with short-term gains. An active investment strategy requires a significant amount of time and research to outperform the market.

    Unfortunately for active investors, the vast majority are unable to outperform the market. According to the S&P Dow Jones Indices, over 75% of actively managed funds failed the market over a five-year period. And that number gets worse over time: at 10 years old, 85% won’t beat the index and at 15 years old, 92% can’t beat the index …

    Active vs. Passive Investing: Pros and Cons

    Every investment strategy has advantages and disadvantages. Here’s a closer look at the pros and cons of these investment styles.

    Benefits of passive investing

    Passive investing has several benefits, including:

    • Lower fees: Passive funds do not require a fund manager to select stocks. This means that the investment fees can be significantly lower.
    • Tax efficiency: Passive investors have a buy-and-hold mentality. This leads to less taxable events to minimize capital gains each year.
    • Easy to understand: Passive funds usually have clear definitions of the assets they contain.

    Disadvantages of passive investments

    As with all financial strategies, there are some drawbacks to be aware of with passive investing. These include:

    • Limited options: As a passive investor, you will likely have to choose from a selection of predefined indices. Although you can work with many different brokerage platforms, the basics of many index funds are very similar.
    • Average return: Passive investing should keep pace with the market. You are giving up all chances of beating the market.

    Benefits of Active Investing

    There are a few potential benefits of active investing. These include:

    • Flexible options: An active fund manager can adjust the portfolio at any time without having to stick to a specific index.
    • Complex investment strategies in the game: Active fund managers are free to try various techniques, including market timing and short selling, to improve their performance.
    • Potential for above-average returns: If you or your fund manager select some big winners, chances are your portfolio will outperform the overall market.

    Disadvantages of active investing

    As with all financial strategies, there are a few drawbacks to active investing. These include:

    • Higher cost: The human component of an actively managed fund makes this strategy more expensive. If you decide to actively manage your own portfolio, you will have to reckon with considerable time costs.
    • Potential for below average returns. As mentioned earlier, most actively managed funds fail to beat the market. So you may end up paying more for an active fund that does worse than a cheaper passive fund. Or, if you are actively investing yourself, you will underperform.

    Passive Vs. Active Investing: Which Is Best For You?

    Both passive investing and active investing can be suitable strategies for investors. However, it is up to you to decide which option is right for you.

    If you want a hands-on approach to investing, a passive style is a better choice. You can expect reasonable returns that are in line with the market average over the long term. Plus, you can make sure you don’t overpay for mutual funds or ETFs.

    On the other hand, if you want to create a personalized investment experience and have the time to embrace this strategy, then active investing might be for you. Even investors with a short-term mindset could benefit from an active approach.

    Before diving into an active approach to investing, take some time to learn the basics. Without a basic understanding of the stock market, it is better to stick with a passive approach until you have enough time to learn this skill.

    Final thoughts

    As an investor, a passive or active style may best suit your needs. It is important that no form of investment is directly better than the other. However, each strategy will better suit the needs of a particular type of investor.

    Before deciding which one is best for you, take some time to consider your investment goals. Do you need help deciding which investment strategy is right for you? Take a look at our ultimate guide to investment strategies.

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