Active vs. Passive Investing: What’s the Difference?

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As an investor, it’s likely that you’ve spent at least some time wondering how involved you need to be in your portfolio. Many investors report that they’ve been known to swing from one extreme to the other: on some occasions, they might feel the urge to micromanage their investments, for example, while on others, they may feel like hiring external expertise to help them along.

In that binary lies the short answer to a key question: what’s the difference between active investing and passive investing? The former, in a nutshell, refers to a type of investment where the investor plays a strong and decisive role in deciding what assets to buy, hold or sell – and when. The latter refers to the practice of ‘setting and forgetting’ an investment – and perhaps letting others do the hard work in return for a fee, perhaps through tracker funds or a similar product involving a manager. This article will delve into the interesting differences between these two diverse types of investment focus and will help you decide which approach might be right for you for the long term.

Time and money

The first and most obvious, difference between active and passive investment is the time required to follow one or the other of these modes. An active investor is inevitably going to spend far more time on their investment pot than a passive one because they will need to spend time researching its individual components and making decisions. If you’re an active stock trader, for example, it’s likely that you’ll be reading a lot of material to get a technical and fundamental understanding of the financial position of the asset you want to trade. This may include quantitative data such as profit and loss statements, as well as broader analysis of the relevant sector – perhaps in newspapers or online.

While there is a time cost involved in active investment, there’s also a potential financial gain. If your decisions turn out to be lucrative, you’ll be able to reap the rewards almost in full – with perhaps just a fee to your broker to be paid. As a passive investor, any successful trading decisions will have been made on your behalf by your investment manager once you selected the fund or index you wanted to track. You will have saved time, but the financial cost will be higher – as the manager will, of course, take a fee. Fund managers such as Buckley Ratchford, who has a successful career managing wealth at Goldman Sachs, are worth the money though – so they’re worth looking into.

Control and autonomy

The next key difference between an active and passive investment that you need to consider is control. Some investors have a commitment to avoiding certain assets or indeed entire asset classes, perhaps due to volatility or ethical concerns. Some investors choose to avoid cryptocurrency investments on the basis that their prices can change so quickly, for example. Others will avoid tracker funds that have any connection to fossil fuels.

As an active investor, it’s much easier to control this and ensure that you don’t invest in something that you’re not entirely happy with. An active investor’s portfolio is simply the product of lots of individual decisions on the part of the investor – and if the investor decides to avoid certain things, they can. However, while active investment offers you full control over your investments, it’s certainly not the case that passive investing is entirely devoid of autonomy. Fund managers have responded to these questions of volatility and ethics by developing funds that appeal to these market demands – so if you would like a passively invested fund that only deals in stocks that are deemed to be ethical by some particular standard, for example, you can.

Holding your nerve

Sometimes, the term ‘active investment’ is confused with the practice of buying and selling assets on a very frequent basis, while the term ‘passive investment’ can be interpreted as never giving up a particular asset once it has been bought. However, these two terms don’t necessarily have anything to do with the frequency of buying and selling.

On the contrary, it’s possible to be either an active or a passive investor and still hold your nerve – even in a downturn. Whichever of these modes of investment you choose, it’s still necessary to have a strategy in place to deal with whatever hurdles might get thrown your way. Whether you decide to spend the time on strategy building or you choose to outsource that, it’s still essential to take a long-term view and give your strategy time to succeed.

As an investor, your choice is simple. If you would like to be intimately involved with how your portfolio develops, active investment is for you – but if you simply want the best chance of returns for the least effort, passive investment, and its consequent fee, is ideal.