Active Investing vs Passive Investing


Share on: Whatsapp

Taking investment decisions requires a lot of research and analysis in order to ensure that it is the right mix of investments in one portfolio. It will ensure the maximization of returns has been invested in the long run. The investors also have to keep in mind that the cost of investment is not too high that it will eventually reduce their returns.

Investors can choose many investment products on the basis of various parameters like returns expectation, investment budget, risk factors, etc. However, from a broad point of view, there are two types of investing:  active investing and passive investing.

Active Investing

As the name suggests, active investing adopts a hands-on approach and requires that someone acts in the role of a portfolio manager. The aim of active money management is to beat the stock market average returns and take full advantage of the short-term price fluctuations.

It demands a much deeper analysis and expertise to know when to pivot into or out of a particular stock or bond or any other asset. A portfolio manager generally oversees a team of analysts who look at qualitative and quantitative factors and determine where and when the price will change.

This type of investing requires a lot of confidence that whoever is investing the portfolio will know exactly the right time to buy or sell. Successful active investment management requires being correct more often than being incorrect.

Advantages

Some of the advantages of active investing are:

  • Hedging

An active manager can also hedge their bets using various tactics like short sales or put options. They are also able to adjust specific stocks in all sectors as the risks are too big. Passive managers are stuck with the stocks that the index they track holds, regardless of how they are performing.

  • Flexibility

Active managers are not required to follow a specific index.

  • Tax management

Although this strategy could trigger a capital gains tax, advisors can tailor tax management strategies to individual investors, such as by selling investments that are losing money to offset the taxes on the big winner

Disadvantages

Some of the drawbacks of active investing are:

  • Active risk

Active managers are free to buy any investment they think would bring high returns, which is great when the analysts are correct but terrible when they are incorrect.

  • Expensive

Fees are higher since all the active selling and buying triggers transaction costs. Moreover, you will have to pay the salaries of the analyst team that research equity picks.

Passive Investing

Passive investors limit the amount of buying and selling within the portfolio, making this a very cost-effective way of investing. This strategy requires a buy and hold mentality, that is,  resisting the Temptation to react or anticipate the stock market’s every move.

The time you own tiny pieces of thousands of stocks, you will be able to earn your return simply by participating in the upward trajectory e of Corporate profits over a period of time through the overall stock market.  Successful passive investing makes the investor keep their eye on the goal and ignore short-term setbacks, even sharp downturns.

Advantages

Some of the advantages of passive investing are:

  • Very low fees

Since there is no one picking stocks the oversight is much less expensive.  The passive fund simply follow the index be used as a benchmark

  • Tax efficiency

The buy and hold strategy does not typically result in a massive capital gains tax for the year.

  • Transparency

It is always clear which assets are in an index fund

Disadvantages

Some of the disadvantages of passive investing are:

  • Small Returns

Passive funds do not beat the market. even during times of turmoil, since their core holdings are locked in to track the market. Sometimes, a passive fund may beat the market by a small margin, but it will have a post the big returns active managers want unless the market itself booms.

  • Too limited

Passive funds are limited to a specific index or a predetermined set of investments with little to no variance. Therefore, investors are locked into those holdings, no matter what happens in the market.

Leave a Reply

Your email address will not be published.