Active vs. passive – who or what should make your investment decisions?
It can be like choosing a type of holiday – do you go for an adventure trek, or an all-inclusive beach holiday? Let’s start by understanding the definitions of active and passive investments.
An active set-up is where a designated manager looks after your investments and makes ‘active’ decisions on when to buy and sell stocks on a daily basis; the aim is to outperform markets not only when they rise, but also when they fall.
On the other hand, passive investments are designed to simply track broader market indices, such as the FTSE 100, over time; crucially, they don’t offer the potential to outperform the market. Broadly speaking, you know what you’re getting with passive investment – much like that all-inclusive beach holiday.
What’s right for you?
There are many things to consider before you take the plunge with investing; choosing between an active and passive strategy is just one of them, so how do you decide what’s right for you?
Firstly, there’s the question of performance; passive investors think that active management is unreliable and that it’s hard for any investor to consistently beat the market. They argue instead that passive investments like index funds and ETFs can provide the best low-risk way of investing in a particular market.
Active investors disagree – ‘While only a small minority of active funds outperform the market,’ admits Andrew Summers, Head of Fund Research at Investec, ‘the good news is there are about 40,000 funds available for sale in the UK. So, even if only 10%-15% actually outperform – because of some sort of edge or skill that the fund manager actually has – that is still thousands of options.’
Another point to consider is cost. ‘One of the great things about passive investing is that the fees are lower,’ says Dan Kemp, Chief Investment Officer at Morningstar.
On the other hand, active investors don’t like to accept average returns, which is why they’re prepared to pay a slightly larger fee for the possibility of even higher returns. They’re the ones who pack the crampons and sleeping bag for their next holiday.
Active investment managers also understand that the best way to protect and enhance returns is to adapt to changes in the market. Unlike passive investments, which are tied to an index, active investment managers – and their investors – aim to predict trends and have the flexibility to switch strategy in an instant if the markets take a turn for the worst.
Ultimately then, the choice of active or passive investing comes down to what’s best for you at a particular time and depends on several factors such as cost, financial goals, and risk tolerances.
It’s important though to point out that you don’t have to be one or the other; even committed explorers like to spend a bit of time relaxing on the beach, so why not choose both?
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