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Active and passive investing are two of the most popular investment approaches today. Investors and experts have debated the superior option for many years. Some support passive investing, with its hands-off management and lower costs, while others vouch for active investing, with its promise of higher potential returns and more flexibility.
So, which of the two do you think is the best to work with today? Before answering this question, read this piece thoroughly. It will help you understand why passive investing is trendy today and why some investors are refusing to shift from active investing. We’ve also outlined noteworthy differences between these approaches.
In This Guide
The Growth of Passive Investing
Passive investing has grown at an unprecedented rate. Between 1993 and 2020, its value ballooned significantly from $11 billion to $2.8 trillion.
Passive investing has gained immense popularity in the past few years due to its lower fees and unmatched convenience. As a passive investor, you won’t need to actively manage your account or trade frequently; you only have to buy your favorite securities and hold them. Since there’s minimal account monitoring and trading activities, passive investing presents fewer headaches and helps you cut costs.
More people are also shifting to passive investing for performance reasons. According to an expert report, actively managed funds have outperformed passive funds by over 90% over a 10-year horizon. In other words, passive investors’ odds of success are significantly higher than their counterparts.
Not to forget, passive investing is incredibly easy to understand and dive into. As a passive investor, you don’t need to research, analyze, and pick different assets. On the other hand, active investors have to spend enormous amounts of time assessing individual companies, predicting market trends, researching past asset performance, etc.
Active Investing: Why Some Investors Still Prefer It
More investors now opt for passive investing, but that doesn’t mean active investing is no longer used. Some people still prefer active investing for the following reasons:
- Flexibility and control
Some investors prefer active investing since it affords more control and flexibility. Every active investor has to make active investment decisions on the right assets to buy and sell. While doing so, many active investors feel they are more in control over their portfolios and in a better position to respond promptly to changing market conditions.
- Potential for higher returns
Active investors prefer this strategy to passive investing because they can leverage prompt timing and tactical decisions to their advantage. For instance, an active investor can predict price movements using current market conditions, time their buy/sell orders to match the circumstances, and net the highest returns possible.
- Opportunities from inefficiencies
Active investing often allows traders and investors to conduct extensive research, identify mispriced financial securities, and capitalize on the available market inefficiencies. That is why some active investors have stuck to their guns.
- Risk management
The most avid active investors prefer this strategy because it involves regularly assessing and adjusting portfolios. Every active investor spends considerable time monitoring the performance of their chosen assets and making adjustments based on market conditions and other factors. They also evaluate the impact of inflation on investments to ensure long-term growth. This plays a significant role in curbing risk and minimizing financial losses.
- Emotional satisfaction
The greater sense of control, flexibility, and engagement associated with active investing can be emotionally satisfying. Many active investors also find gratification in the intellectual challenge resulting from the perpetual need to learn, reinvent, and grow. These aspects often make active investing more stimulating than passive investing.
Key Differences Between Passive and Active Investing
Active and passive investing are two distinct investment strategies. Before choosing either, you should know what makes them different. Let’s explore some of the key differences between active and passive investing:
- Management: In passive investing, portfolio management involves a more hands-off and less intensive approach. On the other hand, active investing requires investors or professionals to monitor their portfolios continuously and actively make decisions with the sole objective of outperforming the market.
- Cost: Active investing requires experienced individuals. If you’re not an expert, you’ll need to hire professionals, which can be costly. And if you’re a pro, you’ll still wrangle with higher expenses since you have to trade frequently to capitalize on as many market opportunities as possible. Professional managers and frequent trading aren’t common features in passive trading, meaning lower costs and expenses.
- Time commitment: Active investors spend more time and effort studying the markets and managing their portfolios. Conversely, passive investors save a lot of time and effort after making the initial investment since constant portfolio monitoring is unnecessary.
- Risk/return: Active investing has higher potential returns but is riskier than passive investing. The primary objective of active investing is to beat the market, which doesn’t always work. Passive investing has less risk since it aims to mirror the market index.
Conclusion
Active and passive investing are two different investment strategies, and now you know why. We’ve also explained the factors behind the increased preference for passive investing. That said, we don’t recommend doing something just because others are doing it. Before opting for active or passive investing, sit down and assess your investment goals and risk tolerance. You should also consider the associated costs, time commitment, and expertise.