Passive vs Active Investing: Which is Right for You?

Passive vs Active Investing: Which is Right for You?

There is an age-old debate between taking on a passive, hands-off approach to investment management versus actively managing your portfolio. While passive investing requires a buy-and-hold mentality with a long term perspective, active investing requires a knack for research, attention to performance, and responsiveness to changing market conditions.

What is Passive Investing?

Passive investing is the concept of buying and maintaining your investments for the long-term until they provide you with income, with a hands-off approach and minimal trading involved. The buy-and-hold approach is commonly used with the passive investing strategy as it allows you to put your money to work and leave it alone. By doing so, you allow compound interest to go to work to yield the biggest return on your investment over time.

What is Active Investing?

Active investing is the act of purchasing stocks as prices fluctuate during market hours. The concept behind active investing is to take advantage of market fluctuations by buying low and selling high. Active investors are infamously known for constantly watching their portfolio holdings so they can move in and out of equities without suffering a loss.

The Similarities and Differences between Active and Passive Investing

Similarities:

  1. Both passive and active investing give you multiple investment options. The beauty behind passive and active investing is that you have a plethora of options. This includes stocks, bonds, commodities, ETFs, mutual funds, index funds and other asset classes.
  2. Both require a method for tracking your performance. Whether it’s by trade, dollar amount (and selecting a benchmark), or another metric, you should utilize a way to track your portfolio’s performance when investing actively or passively.
  3. Both require you to schedule time for buying and selling. Whether it’s daily, weekly, monthly, quarterly, or yearly you should be scheduling payment contributions to your investment portfolio to accumulate wealth over a long period through the power of dollar-cost averaging.
  4. Both methods of investing will take some time to master. While many people prefer either active or passive investing, few acknowledge the learning curve that both present. Regardless of whether you want to be a day trader or a long-term buy-and-hold investor, both require a level of discipline, patience, and building good financial habits that you can’t master overnight. There are many moving parts, and you’ll want to have a plan and goals in place so that you can keep track.

Differences:

  1. Passive investing is hands-off investing. Unlike active investing, where you’re trading in and out of different stocks every day, when passively investing, you can buy an index fund or ETF, let it sit, and leave your money to compound over time.
  2. Active investors take on a more hands-on approach. Active investors aim to buy low and sell high. This requires attention to detail that is few and far between, even with more experienced traders.
  3. Passive investing emphasizes the trajectory of long-term growth. Passive investing is for you if you are comfortable with the idea of letting your money grow over time without any intervention or interference. You have to be patient if you truly want to scale your portfolio through passive investing and navigate short-term market volatility.  
  4. Active investing targets short-term gains.  Unlike passive investing which is more automated, people use active investing to try and make quick profits by buying low and selling high.
  5. Passive investing requires very little time. The buy-and-hold approach is hands-off and does not require much monitoring or constant involvement, unlike active investing.
  6. Active investors need to pay more attention. Active investing has little room for error. Active investors must dedicate a lot more time researching and analyzing price projections before choosing stocks to invest in.

The Advantages and Disadvantages of Passive investing

Advantages:

  1. You can save a lot of time. You do not have to exhaustively spend hours or days researching and monitoring individual stocks, funds, indexes, etc. Just pick your investment vehicle or a robo-advisor with a diversified investment plan, and invest.
  2. It is not very expensive. Index funds and ETFs are cheaper to buy and hold, as you avoid building up transaction fees from consistent buying and selling.
  3. You can profit from the power of compound interest. A buy-and-hold strategy gives you a chance to grow your money over time and navigate short term volatility.
  4. It requires very little maintenance. Once you set it up, index funds and ETFs don’t need much attention to detail or time spent monitoring performance and the market.

Disadvantages:

  1. Passive investing may not be the only strategy for everyone. Some people simply enjoy trading daily and checking on their investments all the time, so may choose to partake in both active and passive trading.
  2. It may involve accepting short term volatility: Markets may be volatile from a day to day perspective, which can worry some investors. However, maintaining a long term investment horizon can balance this out, as the market historically has trended upwards.

The Advantages and Disadvantages of Active Investing

Advantages:

  1. Your potential gains can go through the roof. If you go for high-risk trading like buying contracts, the potential gains can be huge.
  2. You can concentrate on just the stocks that you want to own. Unlike buying an ETF or mutual fund, which exposes you to other investment classes, active trading allows you to invest directly in what you want.

Disadvantages:

  1. It is expensive to trade frequently. With every stock purchase, there are fees tacked on. If you are constantly trading, those costs can add up quickly over time.
  2. It is riskier to do. The market can go up, down, or even sideways. If you’re not careful with your investments, there’s always a chance that you could lose everything.
  3. It can be stressful. There’s always one more stock or fund you’ll want to own, and the short term volatility can be overwhelming to manage.
  4. It requires constant monitoring. If you are managing your own investments, you’ll have to check prices, performance, and stock news regularly.

Investing in the Long-Term

As you can see, active investing and passive investing both have their advantages and disadvantages. But when it comes to passive investing, it does not require much time and effort to get started and maintain your investments.

It may take time to grow, but this is a proven, low-risk, cost-effective method that aims to give you the best results in the long run. Open a SmartWealth account for a diversified investment plan which you can invest in for the long term, helping you mitigate risk and stay focused on your goals.

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