Here are the Key Things You Need to Know about Active vs. Passive Investing
Investment success may come down to what an individual puts into the process — both on a monetary level and an attention level. While various types of investment strategies exist, two methods help guide those ventures: active investing and passive investing.
While their names say a lot about what each approach entails, understanding how the two differ can help individual investors find the right methods for themselves.
What Is Active Investing?
An active investment strategy is precisely as it sounds. It’s a method in which individuals take more of an active role in buying and selling their shares. By taking this approach, investors attempt to own investments that look attractive and avoid anything that seems unattractive. Active investors often manage their portfolios with a particular strategy in mind, which could be value- or growth-oriented.
With active investing, for example, value investors can focus on undervalued sectors and have more control over the firms they own. Active investors have the opportunity to outperform the broader market. Individuals who embrace active investment take on more maintenance of their portfolios, face increased taxes if they trade frequently, and grapple with a major risk of active investing: Their portfolio could underperform the overall market.
For hands-on types who don’t want to be that hands-on, investors can hire a financial advisor to invest actively on their behalf or purchase mutual funds that are actively managed.
What Is Passive Investing?
Passive investing is an approach by which investors aim to replicate the performance of a specific market benchmark, typically through the purchase of index funds. By investing in an S&P 500 index fund, for instance, passive investors should generate a return that is approximately equal to the market return.
Rather than singling out specific stocks and purchasing them independently, passive investors buy every company in an index without regard for individual stock prices or fundamentals. Passive investors could execute a value or growth strategy described above by purchasing funds with that orientation.
Passive investors usually hold shares for years or decades. One of the primary risks of passive investing is sensitivity to losses during a downturn. If all you have are S&P 500 shares, a downturn can be as detrimental as it would be for any other investor at the whims of the market. And if the market is expensive — or worse — in a bubble, your future returns might be low or even negative. Between 2000 and 2010, for example, the S&P 500 Index generated a negative return for investors.
In taking a hands-off approach to managing their portfolios, passive investors miss profits from rising stocks that aren’t included in the index they track — and opportunities to buy at a bargain after market corrections.
Active and passive investing can both be applied to value or growth strategies. That said, they each rely on a unique set of criteria that aren’t free of risk.
The best way to hedge against risk is to understand what each strategy entails. Then, diversify across asset classes — including some that aren’t correlated with stocks — and keep your finger on the pulse of your chosen approach to see how it performs.
Are you trying to find your preferred investment approach? Click here to connect with Pekin Hardy Strauss Wealth Management and hear about which option might work best for you.
This commentary is prepared by Pekin Hardy Strauss, Inc. (dba “Pekin Hardy Strauss Wealth Management”, “Pekin Hardy”) for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of any security. The information contained herein is neither investment advice nor a legal opinion. The views expressed are those of the authors as of the date of publication of this report, and are subject to change at any time due to changes in market or economic conditions. Pekin Hardy Strauss Inc. cannot assure that the type of investments discussed herein will outperform any other investment strategy in the future. Although information has been obtained from and is based upon sources Pekin Hardy believes to be reliable, we do not guarantee their accuracy. There are no assurances that any predicted results will actually occur. . The S&P 500 Index includes a representative sample of 500 hundred companies in leading industries of the U.S. economy, focusing on the large-cap segment of the market.