Investing is a critical aspect of wealth creation, and it’s essential to have a well-thought-out investment strategy to achieve your financial goals. When it comes to investing, there are two primary approaches: active investing and passive investing. Both methods have their merits and drawbacks, and understanding the pros and cons of each can help investors make informed decisions.
At EsqWealth, we use various portfolios and techniques that follow both approaches that are implemented as part of a customized financial plan for each of our clients. The goals, time horizon, and risk tolerance of our clients are just a few of the variables that influence the strategy we employ. This brief article examines some of the benefits and potential dangers associated with active versus passive investing.
What is Active Investing?
Active investors take a hands-on approach to buying and selling to try to outperform a particular benchmark, like the S&P 500 Index. They follow companies closely and trade assets to capitalize on short-term price fluctuations.
You can do your own active investing, but because this approach requires time, a high level of market analysis, and expertise, it’s not recommended for most investors.
Instead, investors may choose to invest in actively managed funds. Fund managers have experience with frequent trading and time to devote to research. They have access to a wide range of investment data as well as a knowledge of broader market and economic trends. With this information close at hand, they closely monitor the market and determine the best time to buy and sell stocks based on their research and expertise to maximize return.
Investors may also choose to work directly with a portfolio manager or financial advisor who can help manage their portfolio or build a custom index through direct indexing. Instead of owning shares of a fund, direct indexing strategies allow investors to own the companies that comprise an index directly, providing greater flexibility in how they are bought, sold, and managed for tax efficiency.
A high touch from fund managers and other financial professionals usually means that active investing and management strategies are associated with higher fees than passive investing strategies, which can eat into overall returns.
What is Passive Investing?
Passive investing requires a long-term mindset. This strategy focuses on buying assets regardless of the market’s daily fluctuations and holding them for a longer period. By holding stocks for the long haul and avoiding reacting to short-term ups and downs in the market, you hope to benefit from an overall increase in market prices over time.
Passive investing may also involve buying shares of an exchange-traded fund (ETF) or index fund designed to replicate a market index while minimizing buying and selling. This type of hands-off approach doesn’t require the kind of daily attention and meticulous research active investing does, and as a result, also tends to come with lower costs, potentially allowing investors to hang on to more of their returns.
Which is the Best Approach?
The benefits of active investing include the potential for higher returns and more flexibility and control over the investments. The negatives of active investing include higher costs, increased risks of losing more of your assets, and time necessary to research, analyze, and monitor investments. The benefits of passive investing include lower costs, simplicity, and less time and effort compared to active investing. The negatives of passive investing include limited potential upside and less control.
The right approach for you depends on many different factors, including your goals, time horizon, and risk tolerance. If you are willing to pay a bit more or spend more time for the chance of outperforming the market, an active approach might be a good fit for you. On the other hand, passive investing might be a better fit for long-term goals, such as retirement.
Keep in mind that your investment approach doesn’t have to be all or nothing. You may prefer to hold both active and passive investments in your portfolio. At EsqWealth, we can help you choose the right mix of active and passive investments to keep your short-term and long-term goals on track.
Sources:
https://www.federalreserve.gov/econres/feds/files/2018060r1pap.pdf
