Active Versus Passive: A Quick Guide For Investors

Active Versus Passive: A Quick Guide For Investors

Alfie Reynolds

Alfie Reynolds  -  12th January 2024

Dive in to uncover the basics and start thinking about which approach would suit you.

What’s the difference between active and passive investing?

In simple terms, a passive investment strategy is one that aims to match rather than outperform the market – while the goal of an active management is to beat the market.

As the word implies, active investors buy and sell stocks (or other investments) regularly. They – or their portfolio managers – look for high-performing investments, or those that they predict will perform well. When stocks perform disappointingly, they sell them. Active investing requires a hands-on approach as well as expertise. Ultimately, the goal is to leverage short-term price fluctuations to beat the market’s average returns.

In contrast, passive investors don’t do so much buying or selling. Instead, they hold investments – often indexed or other mutual funds – for longer periods, making this approach suitable for those with a long-term time horizon for growth. By limiting buying and selling, you’re minimising fees, so this is a cost-effective choice. Remember though, passive investing doesn’t give you the opportunity to react to or predict the stock market.

What are the pros and cons of active investing?

Pros of an active approachCons of an active approach
As you’re not tied to a particular index, your active manager can buy stocks with the potential to win big – as well as those that align with your views
Fees are much higher with an active strategy – not just due to transaction costs, but because you’ll have to pay for analysis and resources
Managing risk effectively
You have the freedom to exit stocks or even sectors if the risks get too big – and hedge your bets with various techniques
Potential for human error
Fund managers are human – with an active strategy, you risk investing in an underperforming fund
Minimising tax liabilities
With a bespoke tax management strategy – for example, selling investments to offset taxes on big winners – you could experience tax advantages (though you may have to pay capital gains)
Over dependency on one person
Unlike with a passive approach, an active strategy relies on the skills of one individual – if they move on, their replacement may not be as talented

What are the pros and cons of passive investing?

Pros of a passive approachCons of a passive approach
It’s unlikely that a passive fund will underperform the market index by a significant margin, so you know what you’re getting
You’re locked into your specific index or set of investments, regardless of market shifts
Low fees
Management fees tend to be significantly lower as passive funds follow the index they use and don’t require analysis
Small returns
Unlike with active investing, it’s highly unlikely that your passive investments will outperform the market
Tax efficiency
With a buy-and-hold strategy, you won’t generally have much to pay in capital gains tax
Lack of choice
There isn’t much scope for a strategy that encompasses your specific beliefs or preferences, and you’re generally tied to your fund manager’s choices

What’s the best approach for you?

Ultimately, it depends on your goals and your attitude to risk – something your wealth manager or financial advisor will discuss with you. But it’s important to remember that the two options aren’t mutually exclusive. Often, the most successful strategies blend passive and active strands to diversify your portfolio and manage risk. You might want the freedom to choose specific stocks, for example, while still maintaining investments in funds.

Do you have questions about active or passive investing strategies? Looking for ways to grow your wealth and optimise your investment portfolio?

Whether you’re at the start of your investment journey, contemplating retirement or looking to boost your post-retirement income, our expert wealth managers will explore your circumstances, goals and attitude to risk before creating a dynamic strategy that’s tailored to you.

Alfie Reynolds
Alfie Reynolds

Alfie Reynolds

Director, Wealth Management Division

Interested in a free, no-obligations chat about how we could help grow your wealth and plan for the future with confidence? Just use the link below to book a slot in my diary at a time that suits you.

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