The Difference of Passive and Active Investing
Investing is a complex process involving many terms and techniques that need to be mastered for the most successful results. Your investment advisor is there to help you along the way with this. But it can also help to get a better grasp on some of the terminology.
One set of terms–passive investing and active investing–warrant further exploration so you can really understand the differences. Armed with that understanding, you and your advisor can make the right choice for you.
Passive Investing Characteristics
The overarching characteristic of passive investing is a buy-and-hold philosophy. Passive investors buy a basket of stocks, and buy more or less regularly, regardless of how the market is faring. This approach requires a long-term mindset that disregards the market’s daily fluctuations.
This strategy can be advantageous because many investors have a tendency to sell their stocks during market weakness. Eventually, this weakness rights itself. Portfolio returns that follow passive strategies do not generally out-perform the index they mimic, and they can result in lower after-tax returns.
Active Investing Characteristics
Active investing takes a much more hands-on approach. This strategy has the goal of beating the average returns over time and it can manage after-tax returns more efficiently.
Active investors research and follow companies closely, and buy and sell stocks based on their view of the future. This is a typical approach for professionals or those who can devote a lot of time to research and trading.
Because active investing requires a deeper analysis and expertise than most investors possess, the services of a portfolio manager are necessary. Only with the extensive experience and knowledge of a professional investment advisor will it become evident when the time is right to buy, sell, or hold a particular bond, stock, or other asset.
With their analytical acumen, an investment advisor is able to take a shrewd look at the quantitative and qualitative factors of each investment to determine the best course of action for their clients.
The Pros and Cons of Each
Not surprisingly, both passive and active investing have their pros and cons. Passive investing sometimes has lower fees because no one is overseeing the portfolio or picking stocks. They simply follow the buying and selling patterns of the index fund that’s used as their benchmark. This sense of transparency is another advantage of passive investing.
However, passive investing also has some disadvantages. Passive funds have predetermined holdings (index fund) or set of investments and investors are locked into them– regardless of how the market might be acting.
It’s also important to note that passive investments won’t beat the market with huge returns. In-stead, investors will potentially just see market-like gains over time. Passive investment strate-gies usually do not allow for personalized tax strategies and may result in an unexpected tax.
Active investing, on the other hand, is a more interactive approach that offers flexibility, versatility, and customization.
Using this strategy, investment advisors are free to choose stocks in different weights than those included in an index. Because of this, they can purchase stocks and other assets that might be up-and-coming or that have more earning potential.
Another advantage of using active investing is that your investment advisor can implement a range of techniques that are designed to protect your investments as well as make them grow.
In addition to being able to invest in any stocks or other assets that have substantial growth potential, following an active investment strategy means that your investment advisor could take advantage of put or call options, and can exit from assets if the risks become too great.
Capital gains (or losses) are a result of any investment strategy— be it passive or active. While a capital gains tax could be triggered by using active investing as a strategy, your investment advisor can customize tax management techniques to help offset the liability when it occurs. Investors who use passive investment strategies can fall victim to higher than expected gains or losses when other passive investors buy or sell during periods of market volatility.
How an Investment Advisor Can Help You Choose
The best investment advisors are those who possess a few core characteristics.
In addition to being a fiduciary and not receiving any incentives for recommending certain investment vehicles to their clients, your investment advisors should listen carefully to your goals and understand your level of risk aversion.
Only by learning about these can an investment advisor develop the other characteristic that makes a good financial guide: a unique investment plan.
Whether you have little aversion to risk and plenty of time to ride the ups and downs of the stock market, or you need a more conservative approach to investing, your financial advisor will likely recommend a mix of stocks, bonds, and other assets.
This combination–which is customized to meet your financial goals–is one that can be easily changed and adjusted at any time since it’s an active investing strategy.
Sometimes a portfolio manager will recommend that a portion of your portfolio be invested in a passive strategy. Oftentimes, passive investments are used to provide diversification of different asset classes or to help manage overall risk. Including both passive indexing and active investment strategies can provide investors with the best of both worlds.
Passive and active investing provide investors with the types of advantages that can lead to a diverse and stable portfolio. It’s important to discuss these options with a professional investment advisor who can create a customized investment plan that’s designed to meet your goals.
If you’d like to learn more about which strategy is best for you or other ways an investment advisor can assist with your finances, we’d love to help. Get in touch with us and see how we can help you meet your financial goals.