What’s The Difference Between Active And Passive Investing?

*This is a collaborative post on the difference between active and passive investing. All words are my own

Investing is such an important part of future-proofing your finances. I’ve spoken about the marvels of compound interest before and how much it can change your investments when you let it grow over time. But now I want to talk more about the specifics of investing, including what the difference is between active and passive investing.

Now I’m no financial advisor so can’t offer advice as to what is the best type of investing for you. But I can give you some facts about the two types so when you do go out to invest for yourself you know what they mean.

What is active investing?

The main difference between active and passive investing is that active investing requires a hands-on approach. This is typically done through a portfolio manager, but it could be someone else. The goal of this type of investing is to try and beat the stock market’s average returns. Ultimately this is to make more money. But this usually comes at a cost as you are generally paying someone to actively manage your investments.

Active investing involves a much deeper analysis and more expertise on the market. Or on particular stocks and bonds that make up your investment. And active investing requires confidence in the person managing your investments. They need to know exactly the right time to buy and sell shares to maximise potential profit.

What is passive investing?

Passive income requires a lot less buying and selling usually ends up with investors buying index funds or other mutual funds. These tend to be things you buy that are made up of lots of smaller investments. This means you can leave it for longer as if one investment drops a bit, another should increase a bit to even it out. Although with investing there are no guarantees.

The differences between active and passive investing

While there are no hard and fast rules if you’re someone like me who is investing in small quantities, and doesn’t have tens or hundreds of thousands to invest then passive investing is probably the way to go. You don’t need to think about it as much and you can use investing apps or other similar platforms to help you get into passive investing.

Another difference between active and passive investing is how long you’re in it for. If you’re a passive investor you invest for the long haul as your buying and selling are limited. Plus generally you buy a bond/ fund/ share and keep hold of it ignoring short-term setbacks. Whereas active investors will buy and sell investments quite quickly when they think there’s a good deal to be had.

Passive investing advantages and disadvantages

• Advantage- Lower fees- As I mentioned above, because someone isn’t actively managing your investment it will cost less to maintain. There’s no one hand-picking your stocks
• Advantage- Lower risk- As you’re in it for the long run there is a bit less risk attached to your investments. You’re not having to pick the perfect moment to buy and sell those shares
• Disadvantage- Lower returns- As passive funds don’t tend to ‘buy the market’ returns tend to be smaller. And it’s unlikely you’d suddenly make a lot of money from investing
• Disadvantage- It can be limited- Passive funds are limited to specific indexes or predetermined investments with less variance. So you’re locked into the companies you can invest in and not able to hand-select them

Active investing advantages and disadvantages

• Advantage- Flexibility- If you have someone actively managing they can buy any investment they think is good, without having to follow specific indexes of funds
• Advantage- Selling when things go down- Active managers can choose exactly when to sell an investment. And hopefully, it will be at the exact right moment.
• Disadvantage- Very expensive- Fees are higher for active investing because you’re paying for an analyst or team to research pick for you, and buying and selling investments can also trigger transaction costs. So if this is done too often it can be expensive
• Disadvantage- Higher risk- An active manager can buy any investment they think is best for you and will bring in the highest returns. This is great when it all works out, but can go horribly wrong if they make a mistake. For example, staying informed with HALO Technologies update on Telstra’s performance on the ASX can help active investors make timely and informed decisions.

Active and passive investing

Only a small percentage of actively-managed funds do better than passive index funds. That isn’t to say that they aren’t as good, but there are more variables at play with them.

Both options exist for a reason as all investors will be different, and those looking to maximise profit may use both methods in their portfolios.

Do you do any active and passive investing?

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