A Quick Look
When investors and wealth managers talk about active investment vs. passive investment, the topic can quickly turn into a heated argument because they tend to strongly prefer one strategy over the other.
Investors are more likely to do passive investing, but there are some good reasons to do active investing as well.
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KEY POINTS
- Active investing requires a hands-on approach, usually from a portfolio manager or other so-called “active participant.”
- When people invest passively, they buy index funds or other mutual funds instead of buying and selling stocks.
- Both active and passive investing are good, but passive investments have brought in more money than active investments.
- Active investments have made more money in the past than passive investments.
- Active investing is more popular than it has been in a few years, especially when the market is going through changes.
Active Investment
Active investing, as the name suggests, is a hands-on strategy that needs someone to act as a portfolio manager.
Active money management aims to beat the average returns of the stock market and make the most of short-term price changes.
It takes a much more in-depth analysis and a lot of experience to know when to buy or sell a stock, bond, or other asset. Usually, a portfolio manager is in charge of a group of analysts.
These analysts look at both qualitative and quantitative factors and then look into their crystal balls to try to figure out where and when the price will change.
Active investing requires trust that the person in charge of the portfolio will know when to buy and when to sell. Active investment management works best when you are right, more often than you are wrong.
Passive Investment
When you invest passively, you do so for the long term. The fact that passive investors don’t buy and sell as much in their portfolios makes this a very cheap way to invest.
The strategy needs a “buy and hold” way of thinking. This means avoiding the urge to react to or guess what the stock market will do next.
Buying an index fund that tracks one of the major indices like the S&P 500 or Dow Jones Industrial Average is the best example of a passive strategy (DJIA).
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When these indices change the stocks that make up the index, the index funds that follow them do the same. They sell the stock that is leaving the index and buy the stock that is joining it.
This is why it’s such a big deal when a company gets big enough to be included in one of the major indices: it guarantees that the stock will become a core holding in thousands of major funds.
When you own small parts of thousands of stocks, your returns come from taking part in the rise of corporate profits over time through the stock market as a whole.
Successful passive investors keep their eyes on the big picture and don’t worry about short-term losses, even if they are big.
In our next article, we shall be covering some of the differences, pros and cons of Active and Passive Investment. Keep and eye on this space and do not miss out.
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