Active vs Passive Investing: The Differences The Motley Fool

Active investing, as its name implies, takes a hands-on approach and requires that someone act in the role of a portfolio manager. The goal of active money management is to beat the stock market’s average returns and take full advantage of short-term price fluctuations. It involves a much deeper analysis and the expertise to know when to pivot into or out of a particular stock, bond, or any asset. A portfolio manager usually oversees a team of analysts who look at qualitative and quantitative factors, then gaze into their crystal balls to try to determine where and when that price will change. Investors in passive funds are paying for computer and software to move money, rather than a high-priced professional. So passive funds typically have lower expense ratios, or the annual cost to own a piece of the fund.

Passive fund charges tend to be lower, sometimes much lower, than for active funds, because there is less ‘added value’ by the provider, in the form of expertise or research needed to pick individual assets. Funds come in many shapes and sizes, and try to achieve different things using their different approaches. There is a fundamental distinction to make between two of the overarching approaches to managing a fund – active and passive investing.

Active Management and Passive Investing Pros/Cons Summary

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They consider multiple measures to assess a stock before making an investing decision. Active investing may offer the potential for higher returns, but it also carries a higher level of risk and requires a significant time commitment. Passive investing, on the other hand, can be less time-consuming and carries a lower level of risk, but may also result active vs passive investing in lower returns. In contrast, fundamental analysis considers a wide number of factors including the status of the economy, stock markets and industry variations in order to measure the intrinsic value of stocks. Intrinsic value is the actual value of an asset after considering all tangible and intangible elements that contribute to its value.

What are active funds?

Because active managers charge higher fees, segregated funds can be tailored to the needs of clients. Funds are often managed like this for high net worth and institutional clients. By contrast, passive products are generic and are considered tools to be used to build a portfolio. Active strategies are more commonly hedged and make use of a wider variety of instruments. Some mutual funds do use basic hedging strategies, while hedge funds make extensive use of short selling, leverage, and derivatives.

Such decisions include tracking the market performance, individual stock performance, analyzing your portfolio investments, and so on. If you’re taking a long-term approach to your investments, you may be slower to react to true risks to your portfolio. If you’re a highly skilled analyst or trader, you can make a lot of money using active investing.

What are passive funds?

It’s like par in golf, and you’re doing well if you consistently beat that target, but most don’t. A report from S&P Dow Jones Indices shows that about 51 percent of U.S. fund managers investing in large companies underperformed their benchmark in 2022, the lowest percentage since 2009. And it’s even worse over time, with about 95 percent unable to beat the market over 20 years. These are professionals whose sole focus is to beat the market, ideally by as much as possible. There seems to be no end to this debate, but there are factors that investors can consider — especially the difference in cost.

• Investment losses are possible, including the potential loss of all amounts invested, including principal.
• For example, you could have, say, 90 percent of your portfolio in a buy-and-hold approach with index funds, while the remainder could be invested in a few stocks that you actively trade.
• This way, you can make your portfolio more conservative as you near the end of your investing timeline and have less time to recover from a market dip.
• Many or all of the products featured here are from our partners who compensate us.
• A vast array of indexed mutual funds and exchange-traded funds track the broad market as well as narrower sectors such as small-company stocks, foreign stocks and bonds, and stocks in specific industries.
• SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates .

They seek to hold the same assets in the same proportion as their benchmark index. Mutual funds that are actively managed typically have a designated portfolio manager, group, or organization. On the other hand, passive mutual fund managers constantly track the performance of a specific industry index or benchmark. Actively managed funds are ideal for investors who want high returns from their investments, as active fund managers try to invest in funds that can beat their benchmarks. The securities/instruments discussed in this material may not be suitable for all investors.

Active investing vs. passive investing: Which strategy should you choose?

The objective of active investing is to outperform the market. In underactive investing, investments are selected based on an independent assessment of the value of individual assets, and an investor is always on the lookout for short-term price fluctuations. It involves extensive fundamental and /or technical analysis, and micro and macroeconomic factors influencing the investment are closely monitored. At the end of the spectrum, you will find hedge funds that embark on aggressive investing involving high leverage levels and focus on absolute returns rather than following the benchmark performance.

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Passive Investing

While some passive investors like to pick funds themselves, many choose automated robo-advisors to build and manage their portfolios. These online advisors typically use low-cost ETFs to keep expenses down, and they make investing as easy as transferring money to your robo-advisor https://xcritical.com/ account. The investing information provided on this page is for educational purposes only. NerdWallet does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks, securities or other investments.

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A fund manager frequently trades in active funds to generate the maximum return on your portfolio investment. Titan Global Capital Management USA LLC (“Titan”) is an investment adviser registered with the Securities and Exchange Commission (“SEC”). By using this website, you accept and agree to Titan’s Terms of Use and Privacy Policy. Titan’s investment advisory services are available only to residents of the United States in jurisdictions where Titan is registered. Nothing on this website should be considered an offer, solicitation of an offer, or advice to buy or sell securities or investment products. Any historical returns, expected returns, or probability projections are hypothetical in nature and may not reflect actual future performance.