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Do you like to be hands-on with your investments, where you’re on the field with the coaches, switching up the plays to try and earn the biggest return? Or do you prefer to watch the action unfold from the sidelines, putting money in steadily but not trying to beat the market? These strategies, called active and passive investing, respectively, are two investing approaches that could help you reach your money goals in different ways.
Active investors buy and sell assets when they think it’s “the right time” to do so in an effort to outperform the market. Passive investors tend to take on more of a buy-and-hold approach, limiting the number of transactions they carry out, and typically try to match, rather than beat, the market.
You may be wondering which approach might work for you. The answer is it depends on your savings goals and comfort level.
Understanding the benefits and drawbacks of both strategies, as well as the importance of having a diversified portfolio, can help you decide which investment style to use and when.
Ahead, we’ll compare active and passive investment strategies to see how each might suit your money goals and investing preferences.
Passive investing is typically a less involved investing strategy and one that’s more focused on the long-term. Passive investors aren’t constantly trading in an attempt to profit off of short-term market fluctuations. Instead, they usually add money to their portfolios at regular intervals, whether the market is up or down. Typically, passive investors believe it’s hard to beat the market, but if you leave your money in, over time you could get a solid return with lowers fees and less effort. Many robo-advisors essentially manage your portfolios, such as retirement accounts, based on your investment objectives.
One of the most common ways to invest passively is to buy index funds – these are pre-selected collections of securities like stocks and bonds that are set up to track the performance of a particular index. Let’s say you purchase a passively-managed index fund that mimics the performance of the S&P 500 Index; if the S&P 500 gains 10% in a year, that index fund should, too. Keep in mind though, any fees associated with the fund will result in a lower gain.
Active investing is a more hands-on investment approach. Someone – either a money manager or you, if you feel confident enough – watches the market and makes changes to a portfolio based on what they believe will bring the greatest potential returns given market conditions. Active investors usually do a lot of research, taking into consideration how market trends, the economy, and politics might impact the best time to buy or sell. While this may seem straightforward, even advanced portfolio managers typically can’t out-perform the markets.
An example of a popular active investment product is a mutual fund, which can include stocks, bonds, and money market instruments. Unlike index funds, which track and watch index movements from the sidelines, a mutual fund is often managed by a money manager, who makes trades actively to determine the game’s progress. But remember, you can also manage mutual funds on your own.
If you think passive investing sounds too, well, passive, know that being a spectator can have its merits. According to Morningstar, passive investing strategies for most investors can perform just as well, if not better, than active ones.
In fact, only 23% of all active funds beat the average of their passive rivals over the 10-year period ending June 2019.
But, that's not the only benefit of a passive approach. Other reasons to consider this investing strategy are:
As with any form of investing, the passive strategy may have drawbacks. These include:
With active investing, the goal is to beat the stock market’s average returns by taking advantage of price fluctuations in the market. When you hire a fund manager or invest through certain robo-advisors, you're trusting them to do this for you. And if you like even more of a hands on approach, you can do the trades yourself, too.
Some benefits of active investing include:
Some drawbacks of active investing could include:
While both passive and active investing strive to earn you the best returns, there’s debate about whether being hands on or off will get the job done more effectively. Which approach you choose will depend on your goals, timeline, and how confident you feel about you or a portfolio manager timing the market. And it’s important to know that the same types of funds can be managed in different ways. For example, you could have an actively managed mutual fund made up of the top 100 companies in the S&P 500 Index, or a passively managed mutual fund that includes all 500 stocks listed in the S&P 500.
After evaluating both investing strategies, you can get started by going through an online broker or robo-advisor. You can also buy mutual funds, stocks, bonds, and other securities through investing websites and apps, or work with a financial advisor who can suggest a mix of assets for your money situation.
Here are some general guidelines that may help point you in the right direction.
With the stock market looking different every day and economists officially declaring that we entered a recession in February, getting a strong handle on what your investment strategy should look like right now is no easy feat.
Remember, there’s no one-size-fits-all approach to investing – perhaps, you'll determine that a mix of both strategies could fit into your goals.
For example, maybe you want to leave your long-term goals, like retirement, to passive investments, but want to work with a money manager in the short term for something you know you’ll want returns for sooner than later, like a down payment for a vacation home.
You can also take a more active approach to your passive investments by adjusting your investment objectives, a strategy called tactical asset allocation, and making sure elements like the stock-to-bond ratio to help potentially maximize returns and match your overall comfort level. This may help you feel some level of control when market conditions are volatile.
The good news is that unlike sports where you’re either the coach or a spectator, with investing, you’re not confined to either active or passive strategies–you can get in on the action when you want to, sit out, or do a mix of both.
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