Active vs. passive investing: which one is right for you?
Here’s how to help choose the right approach for your goals.
What is active investing?
Active investing strategies aim to outperform average index returns, usually through frequent trading and either high-level analysis of financial markets and/or fundamental analysis of individual securities (bonds or stocks). As such, active investors often rely on extensive research, accurate predictions and timing – making this a high-risk, high-reward approach. And because an active investment strategy uses a short-term, buy-and-sell approach, it can incur higher trading fees.
Due to the increased risk, time and cost involved with this strategy, many investors choose to use an actively managed fund as opposed to a DIY approach.
What is passive investing?
Passive investing seeks to replicate the performance of a specific market index or segment by developing a portfolio to mirror its composition and diversity. Investors firmly planted in this camp tend to believe it’s too difficult to consistently outperform the market using active management. In contrast, a passive approach to investing uses a hands-off method that requires less research, monitoring and trading fees.
Active vs. Passive investing: key differences
Whereas active managers and investors may research, buy and sell securities each day, passive managers and investors are more often content with holding a diverse portfolio of investments to achieve their returns over a longer period of time.
Of course, this is the primary difference, but it leaves out a lot of the nuances between the two approaches. To gain a better understanding of the key advantages and disadvantages of each, let’s take a look at the pros and cons of active and passive management:
They aren’t mutually exclusive
Combining active and passive holdings into a single portfolio can allow you to get some benefits from fund manager skills while helping ensure that you still have opportunities from the overall direction of the market. This approach provides both an active strategy that can explore new opportunities and enable greater flexibility, and a passive strategy that can act as a steadier source of returns in the background.
At Edelman Financial Engines, we recommend our clients invest with retirement in mind. That typically means ensuring a diverse and balanced portfolio and focusing on long-term goals rather than short-term gains.
If you’re looking for professional investment guidance, reach out to one of our financial advisors today. They can work with you one-on-one to develop a solid strategy to help you meet your goals and grow your wealth.
Investing strategies, such as asset allocation, diversification or rebalancing, do not ensure or guarantee better performance and cannot eliminate the risk of investment losses. All investments have inherent risks, including loss of principal. There are no guarantees that a portfolio employing these or any other strategy will outperform a portfolio that does not engage in such strategies. Past performance does not guarantee future results.