Investing Passively vs Actively
When it comes to the topic of investment, especially in recent years, there’s been consistent buzz about the importance of investing, and investing well. Investing can feel like an overwhelming topic with too many parts, but one foundational way to approach it is by asking the question ‘should I invest passively or actively?’ Passive investment is a long-term strategy centered on buying and holding assets for the long term. With this style of investment, you’d hold onto an asset through ups and downs with a longer-range goal in mind such as duplicating the performance of major market indexes. Passive investment is a set-it-and-forget-it approach that doesn’t require constant attention. Think of it like fine wine, the longer you hold your investment, the longer it has to mature and give a decent return on investment. Meanwhile, active investment requires a hands-on approach, with active participants or managers involved. This style of investing has the goal of active money management to beat the stock market’s average return and take advantage of short-term price fluctuations. It dismisses long-term trends and focuses on short-term profits. It requires constant attention and deeper analysis to pivot into, and out of, a market (such as stocks, bonds, or other assets).
Let’s focus on the deeper analysis part of active investment- usually, for this, people have a portfolio manager (or they become confident in their ability to manage it themselves). This portfolio manager usually oversees active work to look at qualitative and quantitative factors to try to determine where and when a price will change. It comes down to knowing the exact right time to buy or sell, and active management implies being right more often than not. With either option, it is important to consider the measured expense ratio. An expense ratio measures how much you’ll pay over the course of a year to own a fund; think of it as the management fee paid out to those involved in your asset. A passive investment on average has an expense ratio of .6%; simultaneously, active investments have an average expense ratio of 1.4% according to Thomas Reuters Lipper. Think about it like this, if there are more hands involved there are more people who get a payout. So passive portfolios, since they are less demanding, require fewer people to be involved. Whereas active portfolios are more demanding and require management and staff to support, therefore more people need a payout.
Passive investments can look like an investor putting their money into dividend stocks, high-yield savings accounts, rental properties, and real estate investment trusts (REIT). While active investments can look like investors putting their money into the stock market, hedge fund investments, and exchange-traded funds. With each comes its own set of advantages and disadvantages. Since passively investing is a patient style of investment it has the advantages of being low maintenance/low cost, holding steady returns (and potential for higher average returns), diversified holdings, having lower fees, lower capital gains taxes, increased transparency, and lower risk. However, with that, comes the disadvantages of limited investment options, no exit strategy in severely bear markets, lack of flexibility, fewer windfalls, and the potential to not get above-market returns.
Alternatively, since active investing is a ‘market timing’ style of investment it has the advantages of having risk management, flexibility in volatile markets, tax management, expanded trading options, providing short-term opportunities, and strong holding goal outcomes. While on the other hand, it can also have the disadvantages of cost- including fees (as we talked about expense ratio, active management fees can range from 0.10% to over 2%), increased risk, trend exposure, and the setback of a minimum investment threshold.
This may seem like just a lot of words on paper, but these are valuable things to consider when it comes to figuring out the best method of investment for you. When you think of investing, the fundamental goal should be to set yourself up to make money. Whether it’s a passive or active investment, you must look at what leaves you better off in your goals. Passive income for many reasons can be the best way to go, as it is more structured, less risky, and doesn’t require as much hands-on. Whereas an active investment has high volatility, less security requires you to keep a close eye on market trends, and often requires a portfolio manager to assist you. If you’re looking to score a quick, short-term, potentially high-yield payout, then the active investment might be what is best for you. However, if you’re looking to truly build a solid foundation with a safety net when you invest, then a passive investment might be what is best for you.
