Active vs Passive Investments
Comparing active trading on the stock market versus the buy and hold of mutual/index funds does have its advantages and disadvantages.
Active trading needs an investor to be hands on and in touch with market trends, expertise knowledge on investments and is time consuming. This is beneficial for short term goals mostly and is quite costly. Lets look at advantages
Flexibility: With active investing, portfolio managers and investors aren’t required to hold certain stocks and bonds, which mean they not only have a wider opportunity set to select from, but they can also benefit from short-term trading opportunities.
Risk management: Unlike passive strategies, which flow with a market, active investors can manage their exposure to risk by avoiding or selling certain holdings and market segments. In addition, some active managers can use short sales, put options and other strategies to hedge against risk.
Tax management: Actively managed strategies can be tailored to particular investor needs, such as tax efficiency. For example, an actively managed portfolio can harvest tax losses by selling under performing investments to offset the capital gains tax on outperforming ones.
Actively managed portfolios generally have higher fees than passive portfolios. This is because you’re paying for the expertise of a professional money manager to pick investments and monitor your portfolio.
However, even small fees can chip away at returns and have a big impact on performance. This makes it harder for actively managed funds to consistently outperform their benchmarks: It isn’t enough for an active manager to just beat the index; the fund must also outperform by a margin that is wide enough to cover the expenses.
A major difference between active vs. passive investing is that, with active strategies, investors have a wider range of potential returns. As an active investor, if you make good investment choices, you could potentially see a much higher return than you would with a passive investment. On the other hand, if your investments perform poorly, you could also lose more money.
Active management can really shine in times of volatility and in certain niche markets, such as emerging market and small-company stocks, where information is limited and assets are illiquid.
Passive investing needs an investor to consistently buy and stick to the investment through the lows and the highs of the market, letting the fund recover from losses and gaining growth in the high periods. This is beneficial for long term goals and is less costly than active management.
Advantages of passive investing:
Low fees: Fees are generally lower for passively managed funds because there is less overhead. Nobody is actively picking investments, and there is no need to analyze benchmark holdings.
Transparency: Investors typically know which stocks or bonds are held in an indexed investment.
Tax efficiency: Most index funds do not trigger a large annual capital gains tax because they do not trade often.
However, one of the main drawbacks of passively managed portfolios is that you have less control over your investments, because you’re usually investing in a predetermined selection of securities. This means you won’t be able to make adjustments if certain sectors or companies become too risky or are underperforming.
With passive investing, you earn whatever the market earns, based on the benchmark you pick. This means you participate fully in a market upturn, but you also fully participate in the losses when the market declines.
Passive strategies are generally recommended if you have a lengthier time horizon or are in a situation where you want to minimize fees.
Neither active nor passive investment strategies are mutually exclusive, so you may have a combination of each in your total portfolio.
The decision is for the investor to choose what suits them best. This applies to all assets, liquid and illiquid assets have different management approaches and what may be better suited for an investor will not suit the next. A financial adviser is able to make a recommendation looking at what goals the investor has the expertise level, the time and the capacity the client has.
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