Differences between active and passive investing and why they matter
When you invest your money, it’s a given that you’re willing to take on some amount of risk. There are strategies you can employ to ensure the risk you’re taking is minimal, but it still exists.
If you’re comfortable with a lot of risk to enjoy a greater reward, it’s important to understand that you could lose everything you put in. Of course, most of us aren’t putting our money on the line like that. There is a spectrum of opportunities between taking the maximum possible risk and not investing at all.
One of the ways you can do this is by choosing between active and passive investing. But what do these terms mean, and why does it matter? Read on to find out.
Active investing means remaining involved in the trading process by actively buying and selling your investments. The person managing your portfolio makes decisions concerning what you buy and sell, reacting to conditions in the market. They aim to get ahead of the market by making smart choices that will lead to bigger gains.
That may mean you are doing this work yourself or employing a portfolio manager’s services. Either way, someone is watching, and you’re putting your faith in their ability to spot opportunities to make significant gains quickly and move your money accordingly.
On the other hand, passive investing is a strategy that aims to make gradual gains with few buying and selling moves. It’s cheaper because nobody is managing your portfolio to make short-term gains. Instead, you pursue a buy-and-hold strategy to hold your investment in a broad market index with a long-term gain on the horizon.
The goal isn’t to acquire gains through taking advantage of market fluctuations or hitting on lucky timing. Instead, you’re trying to match the market by creating a well-diversified portfolio that will perform well over time.
Which one earns the most money?
That depends on how long a time you’re looking at. Sometimes a portfolio manager may indeed spot a diamond in the rough and invest at the right time, and the investor will make remarkable gains quickly. Over time, however, passive investing tends to have larger gains.
In this case, the extra fees you would pay your portfolio manager are well worth it. However, it’s not a commonplace occurrence to strike it rich in the stock market.
Who is each type of investing for?
There is no rule about who should invest in what. However, a mix of active and passive investments would be worthwhile if that’s financially feasible for you.
Investors with a higher threshold for risk, such as those with extra funds, are typically more attracted to active investment because the potential gains are appealing and the additional fees associated with having a portfolio manager aren’t as significant for them.
For most of us, however, passive investments are the way to go. Their track record is proven, they are low-maintenance and straightforward, and they come with less stress.
Active and passive investment strategies both have a place in a healthy portfolio and can be undertaken by anyone looking to enter the market. A passive investment strategy will be beneficial if you wish to do something low-risk with a good chance of a healthy return.