This is one of the most talked-about and debated topics in the world of finance and investments. We may not be familiar with the words ‘active and passive investing’, but I’m sure we are aware of the concept. In layman language, Active investing is something where a person actively performs tasks to invest. On the other hand, passive investing is when you don’t need to be active. Either it is automatic, or you hire a person to do the job.
Nowadays, considering everybody’s got a job and many even do multiple jobs, people prefer passive investing. Although, active and passive investing both have ups and downs. But since passive requires less effort and time, it is more preferred and popular.
In this article, I’ll be sharing everything I know about active and passive investing. I’ll talk about both separately with concrete examples. Sounds good enough? Let’s hop in.
Table of Contents :-
As the name clearly suggests, active investing involves one being active! By being active, I mean one needs to perform some steps, do hands-on in order to execute investments. Let us talk about a specific person with a specific role.
Say a Portfolio Manager! What is the work of a portfolio manager? They work actively to execute buying & selling of assets and monitor them too. People who can’t devote much effort and time to their investments hire a portfolio manager. The main task of a portfolio manager is to look into the market and bring excellent returns actively.
One very important trait that one needs to have is Risk Appetite. If you are ready to get huge profits by investing actively, you need to be ready for the worst too!
Anyone can get average market returns while investing passively. But active investing gives one the power to beat the market and generate far greater returns. Active and passive investing both require effort. However, the main difference is –
Active Investing – Focused on short-term gains and potential to beat the market.
Passive Investing – Focused on building huge corpus over a long period of time.
It is for people for are busy, have little or no knowledge of the market, or are lazy. Lazy like me. I believe in passive investing a little too much. If you have a full-time job, studies, and you are in the market for the long term, it is your best option. No doubt.
Passive investing is when a person limits the exchange of assets and time. For example, when you invest more in Mutual Funds. You don’t choose which stock to buy when to buy, you pick up a mutual fund, and the rest is done by others. Paying money is the only job that remains for you. Even if you buy direct stocks, you buy-&-hold. Every stock bought is kept with the purpose of holding. No trading, no intraday!
Passive investing keeps you at ease. You don’t need to read every market move. However, the returns may not be as good as active investing. Let us get some best examples of passive investing –
Index Funds –
I have already talked about index funds on this website. In short, index funds are funds where your money is invested in the top 50-100 listed companies. Index funds, over the long term, are sure to give good returns. You don’t need to need to worry even a bit, and it’s all automated and sure-shot.
I hope these definitions cleared your doubt about active and passive investing. But let us now talk about some specific and key differences –
Key Differences between Active and Passive Investing
Active and passive investing both are suitable for different people with different needs. However, both have some strong and weak points. Let’s us how –
Passive Investing –
- The fee is very low – There is no one working for you throughout market hours, neither someone needs to keep an eye on every market movement. Therefore, charges are super low.
- Tax-efficient – As passive investing is mostly about long-term plans, you don’t get taxed for the massive wealth you generate over the years.
- Transparent – Your assets are always visible and accessible to you.
- Normal Returns – Passive investments don’t beat the market. The returns you receive are lesser than active investments.
- Limited Options – Investments offering passive mode are comparatively low in number. So your options become a bit limited.
Active Investing –
- Flexible – Unlike passive investments, active investments give you flexibility in modifying assets and funds.
- Advanced Options – Active investing gives you the option of ‘short selling’ and ‘future options.’ You can enter and exit as you like.
- Expensive – Unlike passive investing, active investing is very expensive. Expense ratios go up to 1.5%, and intraday charges are also levied. Plus, you need to pay the portfolio manager commission. The constant buying and selling elevate transaction costs too.
- High Risk – We all know, with high reward comes high risk. Intraday and trading are known to break people’s banks if not performed right.
Read More –
What to Choose between Active and Passive Investing?
If you want me to be honest, I’ll choose passive investing. Here is why –
I have a full-time job, and I run this website along with my Twitter account & podcast. I can’t go to sleep if I don’t watch anime. I eat, sleep, work out. The case may be the same with you. In fact, everyone’s got their most of the time booked. In such a case, passive investing proves to be the best option.
As for me, I have invested in Index funds. I buy stocks and hold them for the long term. I hold onto pretty much every asset I buy. And I’m sure that after 8, 10, or 15 years, I’ll have enough corpus, and I know I’ll have earned at least 12% interest. Isn’t that more than enough?
No risk, no mind-boggling, no need to hire someone. Just keep doing what you do daily and invest passively. To me, it feels like a no-brainer. And 90% of the population has the same schedule and preference. However, we can’t generate as much profit as an active investment, but it’s fine!
Active and Passive Investing Both?
Actually, this idea is not that bad. It might even be a good idea! If you are thinking of doing the same, here’s how I’d suggest –
Start investing passively. Please do it for a couple of years, meanwhile learn more about active investing. Research ways to time the market, learn inside outs of trading. And once you’re ready, jump in. Since you’ve been investing massively for some years now, stay invested. Think of it as something bigger, say a retirement fund. Meanwhile, while you learn active investing, save a little extra for that.
Hop in and try your hand, do it yourself or hire someone. I’d say – keep 60% into passive investments and the rest 40% inactive. This way, you play it safe, and you get to experience both active and passive investing.