Active and Passive Investment: Which Strategy is Best For You?

Active investing is buying and holding actively managed funds or equities, in order to generate the best possible returns. You can employ numerous investment techniques to understand when to enter and exit the market, to maximize the returns. However, reports have suggested that during market upheavals, such as the end of 2019, for example, actively managed Exchange-Traded Funds (ETFs) have performed relatively well. In this Active vs. Passive Investing article, we have seen Active investing has the potential to earn higher returns than the market. However, this involves higher costs, taxes, and time for research alongside higher risk due to uncertainty in realizing investment expectations.

• NerdWallet, Inc. does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks, securities or other investments.
• These offerings are not regulated by the DFSA and are not offered to DIFC clients.
• The idea here is that active managers can quickly buy and sell in volatile markets or turn failing stocks in bear markets into cash or bonds to prevent more loss.
• And if you are an active investor, we provide a trading platform – Sarwa Trade – where you can buy and sell securities with zero commission, no minimum investment requirement, and bank-level  SSL security.

It takes out the worry of choosing a strategy or process that is likely to outperform. Moreover, the cost advantage of a passive fund will translate into significant benefit over the long horizon,” said Anil Ghelani, senior vice-president, DSP Investment Managers. The biggest advantage is that active investors can handpick their investments, says Kashif A. Ahmed, a CFP and president of American Private Wealth LLC, based in Bedford, Massachusetts.

Should You Ever Pick an Active Fund or Investing Style?

While passive investing is more popular among investors, there are arguments to be made for the benefits of active investing, as well. Passive investing and active investing are two contrasting strategies for putting your money to work in markets. Both gauge their success against common benchmarks like the S&P 500—but active investing generally looks to beat the benchmark whereas passive investing aims to duplicate its performance. Similarly, mutual funds and exchange-traded funds can take an active or passive approach. Historically, passive investing has outperformed active investing strategies – but to reiterate, the fact that the U.S. stock market has been on an uptrend for more than a decade biases the comparison. In this way, Sarwa allows you to apply both https://www.xcritical.in/blog/active-vs-passive-investing-which-to-choose/ at the same time, or pick the strategy that best suits your personal risk appetite.

Passive investors, relative to active investors, tend to have a longer-term investing horizon and operate under the presumption that the stock market goes up over time. These advisors choose very specific stocks that can deliver that required income (through dividends). Since they know the specific stocks that can provide the dividends they need (and companies don’t change their dividend payout ratio frequently), there is no need to track an index.

Also, digital financial advisors like Sarwa that create a portfolio of passive funds for investors have very low minimum investment requirements (it is $5 for Sarwa). Passive funds don’t have the flexibility of the active management strategy. For some investors, this is especially concerning in bear markets since even if a particular stock or bond is nosediving, it still remains in the portfolio as long as it remains in the underlying https://www.xcritical.in/ index. One of the factors responsible for this underperformance is rising competition among mutual funds, hedge funds and actively managed ETFs. Market return is measured by the performance of a market index, which is a collection of certain stocks or bonds that meet certain criteria. For example, one of the most common indices is the S&P 500 Index, which tracks the performance of the largest (by market cap) 500 US companies.

However, if you have the time and investment acumen, you can also be an active individual investor with whatever amount you have. When you invest in an ETF or index fund that contains hundreds or thousands of stocks or bonds, you gain diversification benefits, which reduces your risk. Every ETF or index fund is diversified by industry (finance, healthcare, consumer discretionary, etc.) and/or market cap (large, mid, low) and/or market (US, emerging, developed) .

For example, in a flexicap or dynamic asset allocation fund, the investor depends upon the fund manager’s expertise to make changes in line with economic and market situations. In some cases, passive funds score on convenience over traditional investments such as in the case of gold. Investing in international markets brings diversification benefits and ETFs are a good way to include them in the portfolio. “The choice of vehicle to invest in international securities will depend upon what you are looking for.

Factor investing has grown in popularity along with the passive investing industry. Thus, exchange traded funds that target growth, value, yield, and other factors are now widely available to investors. Smart-beta funds use a combination of factors to reduce volatility and generate better risk-adjusted returns. The easiest way to implement a passive approach is to buy and hold an index fund that follows one of the major indices like the S&P 500, Dow Jones, or Russell 2000 (small-cap stocks). These funds pool money from multiple investors to buy the individual stocks, bonds, or securities that make up their market index.

Given that over the long term, passive investing generally offers higher returns with lower costs, you might wonder if active investing ever warrants any place in the average investor’s portfolio. You’d think a professional money manager’s capabilities would trump a basic index fund. If we look at superficial performance results, passive investing works best for most investors. Study after study (over decades) shows disappointing results for the active managers. For example, Live Mint, a financial news agency, suggests a passive investing approach for large-cap stocks and an active investing strategy for mid-cap and low-cap stocks.

Active and Passive Investment: Which Strategy is Best For You?

The securities/instruments discussed in this material may not be suitable for all investors. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Morgan Stanley Wealth Management recommends that investors independently evaluate specific investments and strategies, and encourages investors to seek the advice of a financial advisor. Certain information contained herein may constitute forward-looking statements. Estimates of future performance are based on assumptions that may not be realized.

An index fund offers simplicity as an easy way to invest in a chosen market because it seeks to track an index. There is no need to select and monitor individual managers, or chose among investment themes. The active versus passive investing debate in mutual funds is unlikely to have a clear winner. Data on performance and assets under management (AUM) indicates investors’ current disenchantment with actively managed funds.

Despite the fact that they put a lot of effort into it, the vast majority of of active fund managers underperform the market benchmark they’re trying to beat. The investing information provided on this page is for educational purposes only. NerdWallet, Inc. does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks, securities or other investments. For most people, there’s a time and a place for both active and passive investing over a lifetime of saving for major milestones like retirement.

The case is the same for all other fund categories in the active management category. Active portfolio management focuses on outperforming the market in comparison to a specific benchmark such as the Standard & Poor’s 500 Index. The performance can be measured using Active Share and by comparing portfolio holdings to the benchmark. Passive investing returns replicate the underlying index, asset, or security performance that the fund tracks. Passive investments include Exchange Traded Funds (ETFs) and Index Funds.