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Active Vs Passive investing styles compared

There are many types of investors, each having different strategies and goals. For purposes of this article, their investment styles can be categorised into two distinct groups, active and passive. The article provides a breakdown of how active vs passive investing styles may differ in their application to investing.

Are you Actively Investing?

Comparing active vs passive investing styles soon reveals that an active investment seeks to beat the market performance, whilst a passive investment slavishly follows a selected market (or market component) index. Consequently, active investment necessitates keen observation of market developments, and consequently trading appropriately.

Investors who adopt this style as their philosophy, often choose to engage a fund manager recognised for their active style, to manage investments on their behalf.

Some of the pros of active investing

There are presumed advantages to adopting the active approach to investing.

When active investors succeed in beating the market, they experience higher than average portfolio performance. Active investing requires a high level of confidence in market knowledge and having appropriate financial skills: it may involve higher risk – a factor that should be valued when comparing outcomes.

Engaging an active fund manager as suggested above should help to mitigate some of this risk. As a bonus, engaging an active fund manager may give access to products that may not otherwise be available.

… and some of its cons

Putting trust and confidence in a professional fund manager, you need to be prepared for the possibility that, in spite of their best intentions, they could misjudge the market and your portfolio could underperform the market.

It also needs to be borne in mind that when you engage a fund manager to oversee your investments there will be fees to pay for their expertise. These fees usually comprise a management fee as well as an administration fee – and these fees can differ between fund managers (as can their performance – even within a particular asset class).

Active investing is a highly involved strategy demanding considerable time for stock research and analysis, including monitoring corporate announcements.

Are you Passively Investing?

In the comparison active vs passive investing, the latter is often seen as a less complicated way to invest, tending to suit people who would rather take a less stressful approach to managing their investments. They will generally assess as having a lower risk tolerance to investing, compared with active investors.

Passive investing tends to be for the longer term, adopting the buy and hold strategy. These investors need to be able to ignore occasional market setbacks and downturns, which is a different approach from active investors who seek continuity of gains.

Some of the pros of passive investing

The less stressful nature of passive investing suits certain investors, for at least some part of their portfolio.

The typically lower costs of passive investing is attractive to some investors – and the greater transparency of their investments can also be appealing. Knowing where their money is invested provides them with an opportunity to reconsider the index they have chosen to follow passively (somewhat a conundrum, as they may actually become active investors in this process).

… and some of its cons

Passive investment can limit choice – and opportunity – in that there are fewer products available that suit this style of investing. Investors are basically limited to asset class indices, index products (such as index ETFs and index managed funds).

Passive investors will never beat the market (for the index they follow), as they track that market specifically (although, neither will they underperform that market!). Selection of an appropriate index to follow may prove to be as challenging in terms of research and financial knowledge as is required for the active investment style.

Choosing an investment option that’s right for you

Your investment preference will dictate which investment style you adopt in pursuing your financial goals. The passive investment style may suit your purposes if the needs are modest – or far enough into the future; however, if they are shorter-term or more ambitious, active investing with a higher risk asset allocation may better suit your needs.

Whichever investment style you work to, having a clearly-documented, well-considered investment strategy is an essential first step in your investment journey – and, after you’ve been investing for a while, a review of your strategy to ensure it still aligns with your goals and current circumstances is highly recommended.

Modified from an article published in August 2021, by Canstar’s Content Producer, this article was published in September 2022 and may be revised periodically to update to current information.

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