There are few simple, yet not many youngsters are aware of and it is a very important factor to know about investing world for everyone when it comes to managing your own money. It is very important to understand the difference between the two. The two main investment strategies that are primarily used to generate return on your own money are: Passive Investing & Active Investing and I will happily go over both strategies in this article.
Key Take on Main Differences Between Passive vs. Active Investing
For anyone that wants a quick answer, instead of reading the whole post.
Passive Portfolio Management
- Passive Investment Management Strategy primary goal is to match the returns to a particular market index or a benchmark.
- It is primarily designed with much less risk, but also lower return.
- The whole purpose of Passive Investment Management Strategy is to generate the return that’s the same as the chosen index.
- Passive Management does not have a team of Portfolio Managers managing the money and is normally structured as a mutual fund, exchange traded fund (ETF), or a unit investment trust.
Active Portfolio Management
- Active Investment Management Strategy primary goal is focusing on outperforming the market.
- Active Investment Strategy involves a lot more frequent trades than passive.
- It is primarily designed with much higher risk, but has higher returns.
- Active Investment Management has a team of people including portfolio managers, co-manager, team of managers all for a purpose of actively making decisions for the fund which typically entitles to higher fees.
- There’s a lot more moving parts around the active investment strategy as the whole team have to be up-to-date with what is going on around the world at any moment from almost every standpoint.
What is Passive Investment Management Strategy?
Let’s first look at definition from dictionary, Passive – accepting or allowing what happens or what others do, without active response or resistance. It really does hit right on the nail. Passive primarily focuses on safety and less management.
The primary goal of Passive Investment Management Strategy is to match or get as close as possible to returns of a particular market index or benchmark. Passive Investors limit the amount of buying and selling within their portfolios and thus making this a very cost-effective way to invest for people. The strategy focuses on buying and holding approach. In other words, there should be a huge factor or a movement for investors to restructure the portfolio.
Passive Investing has some of the best benefits for many people to feel safe and know what is going on in their portfolio including;
Low fees – Since there’s no team of portfolio managers, the portfolio does not require much of brain work. Passive funds just do their own thing by following the index they use.
Taxes – The buying and holding strategy does not result in huge capital gains in a year which means it is much easier to avoid the hefty taxes on gains from trading frequently.
Major weakness is small returns. Passive funds would pretty much never beat the market, even if the market is doing better than ever because the way the portfolio set up is to track the particular index or benchmark. Every once in awhile it might happen, but it won’t be anything as close as actively managed portfolio.
What is Active Investment Management Strategy?
Let’s first look at definition from dictionary, Active – engaging or ready to engage in physically energetic pursuits. Simply we can say – actively being involved in portfolio management. Active investing requires some hand work and always staying up-to-date with what is going on not just on the market, but also any economic factors around the world. The primary goal of active investment management strategy is to beat the stock market’s average returns and take full advantage of the short-term price increases.
There is a lot that goes into active investment management strategies and a team of portfolio managers with all kind of skills and expertise which helps to practically predict what is going to happen with any asset, bond, or a stock. It might sound simple, but it really takes a poll and could cost a large amount of money for the investor if making a wrong move.
Active Investment Management Strategy applies the mentality of buying and selling frequently which results in higher risks, as well as higher the returns in real world.
Some main benefits of Active Investing:
Flexibility – As simple as it sounds, active investing allows the investor to pull trigger on nearly anything they want if they think that that is the next big thing.
Moving money Around – Active Investors can exit certain stock or market whenever the risks or some bad news burst about the company or a sector, meanwhile passive managers are stuck with what they have.
Taxes – Surely, there are capital gains to worry about due to selling in a short period of time, active managers can really offset this factor by selling investments that are losing the money and avoid massive capital gains taxes.
Major weaknesses are: highly risky & expensive. It is not really a weakness but it is something that comes with active investment management strategies. Expensive because it costs money to actively manage fund and teams of analysts that really cost money if they are more wrong than right. Highly risky because when analysts are right to predict the great return, it is not so fun when it turns out a bad move or investment.
Who is the Winner Here?
There’s not really a clear winner here, but statistics show that passive investing is still a most popular (how much money is invested) option and also many studies over years show that active investing have disappointing results and only a very small amount of active mutual-fund investors really outperform the passive investing. Both investing strategies seem simple, yet very complex as to what exactly each does and there are positives and negatives to each.
Today, with current market active investing is gaining attention and is slowly taking the share of total invested. It is actually much more beneficial to combine both active and passive which result in safety and less risk involvement where hedge fund managers shifting to investing portion into index fund.