Active versus Passive Investing

Darryl Bachmeier
Jul 20, 2020
Finance


Financial literacy can help you maximize your income potential. It elevates your goal setting from survival to savings. And one of the core lessons you have to learn is investing.

Investing gives your cash more power by beating inflation. It also prepares you for the future – the time when your priorities shift and you want to take a rest from work.

In the same way, your investments can help you get through life’s uncertainties like disability, sickness, crisis, or loss of income. Some people can also use the profits from their investments to fund future projects or have something to pass on to their children.

Regardless of the purpose, investing is a wise decision today that can help you tomorrow. Though, not everyone’s equipped with knowledge on how to start one. Financial literacy has many confusing aspects since it is dealing with calculated risks and predictions. It takes time to understand these concepts and put them into practice.

I am aiming to drive down the concept of investments as simple as it can be to encourage more people to venture into it.

Why Invest?

Investing does not guarantee fixed returns, but it’s a fact that it puts your income capacity and savings today in a better position tomorrow. Along the journey, it also builds your discipline by making financial decisions and stewardship.

Now, there are many ways that you can invest your money, but it boils down to two main approaches - active and passive investing.

When financial advisors compare the two, they will most probably do so in the context of which is better in giving higher returns. The debate is still ongoing and there is no one yet to testify from experience which one is the best.

To set your expectations, most successful investors attest that the combination of both is the best way to do it. And there’s no magic formula since the market is moving and evolving every minute. What you can only do is to take in as much past data as to process trends and insights. The rest is to remain hopeful, watchful for critical movements, and act on your instinct.

And, investing does not have to be doing it yourself.

More often, it adds to the risk of losing when inexperienced people handle their own investments. The good thing is that many professionals are passionate about it that they can lend a hand in guiding or even managing your own. But of course, for a profit. But in the end, it still becomes a win-win for you both.

Meanwhile, another key to successful investing is diversification. As the adage says, “do not put all your eggs in one basket”. It lessens your risk and your winnings on one can compensate for the losses of the other. Strategies work in investing. Data-driven strategies.

Active Investing

If you are passionate about numbers, statistics, and market movements, then you’ll definitely like active investing.

The concept of active investing is watching for market movements and taking advantage of the best times to buy or sell investment shares. The goal is to beat the market and grow your money through it.

In context, active investing is all about the right timing.

For the investor, it requires robust portfolio management strategies and a broad understanding of financial behaviors, market performance, and risk management. Hence, people who have a strong appetite for numbers and their impressions believe that it is possible to make money by understanding market movement. That is, knowing when and how long to hold a share or when it’s time to sell it for maximum profit.

Other benefits of active investing include:

Better flexibility

It gives more flexibility to diversify your investments. You can easily opt-out or transfer your shares to another investment that you find having bigger growth potential at the moment.

Risk management

Short term goal setting, which is only possible with active investing, provides you with stronger risk management measures.

More control

Overall, active investing gives you more control over your investments. But only in the aspect of diversification and risk management. The rest like profiting still lies in your ability to discern the opportunities and to time your buy-sell decisions.

Active investing applies to all types of investors, but according to studies, the majority of people into it are those with higher risk appetite and have more money to shell (or ready to lose).

To maximize your potential returns in active investing, it’s either you acquire the skills of the trade, or you’ll get the person who has the best skills to manage the portfolio for you. Either way requires significant time in studying and learning from trial and error. After all, doing active investing isn’t consulting with the cards, the stars, or a magic ball. It is about statistics, trends, impressions, and a profound understanding of all the fundamentals in finance and market movements.

Passive Investing

When you are new to investing, you can start venturing to passive investing first. The learning curve here is less complicated and you don’t need to devote so much time engaging with your investments.

Some investors are claiming that passive investing provides higher returns overall. This is because you are venturing into companies that are more stable in terms of growth and market performance.

Here are other strengths of passive investing:

Lower fees and taxes

To maximize returns, you also have to consider management fees. Since there is less time involved in managing passive investments, the money you save on professional fees adds up to your profits.

Meanwhile, you can also save on tax payments since index funds (another term for passive investments) do not trigger bigger capital gains at the end of the year because of their buy and hold system.

The con is investing actively is passive’s pro. If you are specifically worried about fees, then you can see better value in passive investing.

Transparency in investments

Unlike with managed active investments, you can know which companies you invest in unlike in its passive counterpart. It’s either what’s on the S&P 500 or the Dow Jones Industrial Average list.

The Verdict

Getting yourself educated about the financial market and the world of investing is part of the so-called essential life skills. Aside from discipline, it helps build more responsible purchase habits, even gives you a fresh perspective on how to make money work for you.

Active versus passive investing will remain a valuable topic to discuss, and as the market continues to grow at an unprecedented rate, we’ll never know which wins until we discover it ourselves.

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