If you surveyed 100 people who have forayed even partially into the world of finance and investing, and asked “what is active investing?”, they would likely offer up some explanation of the difference between Active and Passive investment management.
In this article, Thomas Rogerson, Director of Wealth Management at Pyrmont Wealth, explains the difference between the two.
Active vs Passive Investing
Active investment management is considered to be picking stocks (eg. Apple, Tesla) the investor believes to be under-priced, in the hope that their selection will outperform the broader market (e.g. in the case of the US, the S&P 500 index). Over time, this has been proven to be very difficult in practice, more on than another time.
Passive investment management typically accepts that trying to pick out the winners and avoid the losers is futile, and would instead buy an investment which aims to mimic the performance of that broader market (e.g an S&P 500 Tracker fund).
Over the last decade there has been a clear trend of investors favouring the “passive” approach.
So Should You Be an Active or Passive Investor?
Here is where things get ambiguous. I believe you should be an active investor, but use passive investment management.
“What does that mean?”, I hear you say.
Let’s say you have no interest in spending a great deal of time on your investments, in fact, you want to make one decision and never look at it again. You receive an inheritance, and decide to invest it into an actively managed fund for the next 20 years. And then you do nothing. You sit, you get on with your life, and you come back in 20 years to a fund which, statistically, is likely to have underperformed the market.
On the flip side, an active investor, would first:
- Evaluate their goals for the inheritance
- Establish some risk parameters based on the return they were looking to achieve
- They would need to select the appropriate asset allocation (stocks/bonds/real estate etc) to give them the best chance of achieving that return
- Decide on which instruments to actually buy in order to participate in the return of the asset classes they chose (Equity funds/Bond funds/a house etc.).
As an advisor, I would recommend they choose passively managed funds to build their portfolio, but it doesn’t stop there for an active investor.
Markets go up and down so the split between the different asset classes will change, requiring you to regularly rebalance the portfolio, to maintain the appropriate level of risk and potentially benefit from market downturns.
Life also changes, the investor may get married, have children, win the lottery, encounter health issues, so in turn their goals may also change. These changes may merit an adjustment to the investment strategy.
Building wealth through investing is a marathon, not a sprint, and you will need to navigate your portfolio through life’s changes and challenges to ensure you stay on course.
As an advisor, this is where regular progress updates with clients are vital.
We don’t talk about which stocks are hot and which are not, we dig deeper into your Why? Why are you investing? What are you investing for? How can we optimise your chances of success?
At Pyrmont Wealth, we do exactly that. Our Life-Centred Financial advice and Evidence Based Investing approach helps you to understand your financial future and allows you to see how you can spend your time doing what you want to do,
Book your FREE, initial consultation to learn more.