A portfolio typically consists of individual shares, ETFs, or managed funds. These can either be actively managed or passively managed. The investment style you prefer is a personal choice, but it is important to understand more about each style. To ensure you make an informed decision, let’s talk about Active vs Passive investing.
Active investing is when a fund manager or investor invests with the aim of beating the market return. This is done by using share selection and market timing. It involves ongoing buying and selling and requires continuous monitoring. The goal is to buy undervalued shares, make a short-term profit, sell them, and reinvest into other undervalued shares. This style takes a short-term focus, looking regularly at price movement in a bid to achieve greater growth and outperform the market.
Underlying investments don’t have to follow any specific index. The investment weighting position can be changed quickly and can move to a more defensive position in a volatile market or can reallocate to a more aggressive position in growing markets.
This type of investing can trigger capital gains, due to ongoing buying and selling. However, fund managers and investors can control the sales of underlying assets that create a capital loss to offset any gains, helping with the management of tax.
With an ongoing buying and selling approach, the more you buy and sell, the more broker fees (or transaction costs) you attract. If you invest via a fund manager, you are also paying higher management costs.
If you get it right you stand to win big, but it only takes one investment to drag the performance down. Looking for those shares that are going to outperform, often involves speculative buys which can sometimes result in big losses.
It is sometimes easy to jump on the bandwagon and follow trends to seek that quick short-term profit, however trends are quite often that, just trends and it becomes difficult to determine if you are at the tip of a trend or if there is still room to grow.
Passive investing attempts to replicate market performance by tracking a specific market index rather than trying to outperform the market. Passive investing adopts the philosophy of “buy and hold”.
Passive investing seeks to avoid frequent buying and selling of shares with the view to buy investments to own for the long term. Passive investing doesn’t pursue to profit from short term-price movements or market timing. This type of investing takes a long-term view on seeking profit with a goal to build wealth gradually.
As passive investing has a “buy and hold” philosophy, there are reduced brokerage costs. If you are investing via a managed fund, then the expense cost is lower than an active fund.
Passive strategies tend to be more fund-focused usually investing via ETFs or managed funds providing diversification across hundreds of shares. This decreases the risk of one investment going bad impacting the whole portfolio.
What you see is what you get with passive investing. These investments are tracking an index (e.g., S&P 500) therefore the ETF or Managed fund will never hold investments outside that index. Many also have the index name as part of the investment name.
Passive funds are limited to a specific index that is pre-determined, therefore these are the holdings held, no matter what happens in the market.
Passive funds will never beat the market by design.
Active vs Passive Investing Debate
Each approach has its own merits and inherent drawbacks that an investor must take into consideration. There is no correct answer on which strategy is “better,” as it is highly subjective and dependent on the unique goals specific to every investor.
Active investing has proven to have strong returns over a short period however in most scenarios when returns minus costs has been analysed over a long-term time frame, the results show that passive investments have outperformed in many years. The active investing market is highly competitive, and it is hard to find ways to outperform the market.
Research house Morningstar completed an analysis into Active vs Passive fund performance and they stated, “in general, actively managed funds have failed to survive and beat their benchmarks, especially over longer-term time horizons,”. Conversely, the report also acknowledged in the 12 months leading up to the research “active funds success rates had increased in 11 of 20 categories examined”. The research suggests that actively managed funds have their place and can outperform the market, however it is usually more successful in a volatile market and over a short-term time frame. Over the long-term passive (index) funds have the better track record.
When it comes to Active and Passive investing there is no right or wrong answer. You may already know which style you align to, and if not, this article has confidently explained both styles and you now have a better understanding of Active and Passive investing.
When it comes to which style is appropriate for you and your investments, that depends on your individual circumstances and your goals and objectives. A conversation with a financial advisor can not only help you fully understand Active vs Passive investing but can also ensure that you are invested suitably.
Get in touch with us today for complimentary consultation to discuss your financial position and we can provide you advice tailored to your unique situation.