Active Vs. Passive Funds: Which is Right for You?

By Jomathews

stock price Active Vs. Passive Funds

 

The investing world can be confusing, and it’s easy to get caught up in buzzwords and catchphrases. Even experienced investors sometimes struggle with keeping up with the latest terminology. The world of investing is full of specialized terms and acronyms, which makes it difficult to know where to begin when looking at your options when it comes to growing your money. Luckily, there are several resources out there designed to help people get started. One of the most important things to remember is that investing isn’t a one-size-fits-all game. There are several different options available, and the best one for you will depend on your circumstances. With that in mind, let’s take a look at some of the common terms you might come across when researching different investment options to help you get started. Fortunately, you don’t need to be a financial expert to understand the basics of investing and what different investment types mean for you. This article will introduce you to two main types of investment strategies commonly used by individual investors: active vs passive investments. Keep reading below to learn more about these concepts and how they might impact your financial strategy.

 

What’s an Active Investment?

An active investment strategy is one in which the investor actively manages their portfolio. Active investors might use options or futures, employ short selling, or make trading decisions based on macroeconomic factors. Macroeconomics is the study of economic activity on the scale of a country or a region. It refers to the large-scale view of how economic forces influence financial markets as a whole as well as the investment options within those markets. Macroeconomic factors can include economic events such as interest rate changes, fluctuations in the value of the currency, legislative initiatives that impact the markets, or changes in unemployment or inflation rates. Active investing can either be short-term or long-term, depending on the individual investor’s goals. One common example of an active investment strategy is trading stocks. When trading stocks, investors have the option to either buy shares of a company that they feel has strong potential for profit or sell shares in a company that they feel has limited potential for future success. Active investors might employ a range of strategies, such as buying and selling stocks based on the value of the company in which they’re invested, buying and selling shares based on macroeconomic factors, or buying and selling options in an attempt to get a better price on a stock they want to buy.

 

What’s a Passive Investment?

A passive investment strategy is one in which the investor doesn’t actively manage their portfolio. Passive investors might employ a buy-and-hold approach to investing, or use low-cost, highly-efficient index funds. These funds track the performance of a given market (e.g. the S&P 500, the U.S. bond market) and are typically much cheaper than actively-managed funds. In addition to low expense ratios, index funds also have minimal turnover, which means they buy and sell individual securities very infrequently. As a result, they incur significantly lower transaction costs than actively-managed funds. Index funds are widely available, and many investors choose to forgo actively-managed funds entirely. Index funds can be a great option for many people, but they aren’t necessarily a good fit for everyone. Index funds don’t allow you to diversify across asset classes. Passive investing can either be short-term or long-term, depending on the individual investor’s goals. One common example of a passive investment strategy is buying and holding a low-cost, diversified index fund. Investors who employ a passive investment strategy are essentially hoping that the market will increase, allowing their investment to grow over time. Passive investors might purchase a low-cost index fund that tracks a specific market, such as the S&P 500. They then hold onto this investment for the long term, hoping that the market will increase and their initial investment will grow over time.

 

What’s The Difference Between Active and Passive?

Active and passive investment strategies have a few major differences. First, active investors are likely to incur higher levels of trading and transaction costs, which could lower the overall value of their portfolio over time. Passive investors are likely to incur lower levels of trading costs, which can help keep their costs down. They may also be less likely to trade at the wrong time because they are not actively timing the market. Passive investors are less likely to make rash decisions due to unexpected market fluctuations. Additionally, passive investors are less likely to engage in excessively speculative or risky investments. As these types of investments are outside of their scope, they are less likely to encounter significant losses.

In the long run, these factors can help to reduce the overall costs of passive investing. Another important difference between active and passive investing is that passive investors are relying on the market to increase in value over time for them to see a return on their investment. They aren’t attempting to “beat the market” or buy low and sell high like active investors are. Active investing is all about trying to find stocks that are undervalued and sales that are overvalued, then taking advantage of the difference and getting an initial edge in the market.

 

Why is it Important to Know the Difference?

The difference between active and passive investments may not seem like a big deal at first glance. However, the more you understand about each type of investment, the better prepared you will be to make smart, informed decisions when it comes to growing your money. Investors who employ an active investment strategy often use short-term strategies as a way to beat the market. These strategies are risky, which can lead to high levels of risk in the investor’s portfolio overall. Investing in passive, long-term strategies can help to balance out the risk of an active portfolio and make it more manageable. Investors who are knowledgeable about the difference between active and passive investments can make more informed decisions and find a strategy that works best for their skill set and investment goals. Passive investments are better suited for people who are hands-off and don’t want to actively manage their investments. These investors might be more comfortable with a diversified portfolio of mutual funds or exchange-traded funds that closely track an index. Active investors, on the other hand, may be more interested in actively managing their investments by researching individual stocks to outperform the market. These investors may want to focus on stocks that they feel have the greatest potential for growth.

 

How to Start Building an Investment Strategy

If you’re new to investing and looking for a way to jump in and get started, passive investing is a great place to begin. Investing in low-cost, diversified index funds can be a great choice for those just starting out. There are a few things you’ll want to keep in mind as you start to build your investment strategy. First, make sure that you have a clear goal in mind for what you’re investing in. Are you saving for retirement? Do you plan on buying a house shortly? Are you looking to make an investment that will yield some cash while you’re waiting to save enough for something big? Once you have a goal in mind, you can start to make a plan for how much you’ll need to save and where you’ll invest your money.

 

Bottom line

When it comes to investing, there are a few basic concepts that everyone should be familiar with. Active vs passive strategies are two of the most important concepts to understand when it comes to investing. Active investing involves actively managing your portfolio, which can lead to higher levels of transaction costs. Passive investing, on the other hand, involves investing in a diversified portfolio and holding it for the long term.

In the long run, passive investing is likely to outperform active investing. That’s because active investing is more expensive and challenging to do well. However, there are situations where active investing can be beneficial. For example, if you have a high-risk tolerance and the ability to stomach significant variation in your portfolio’s value, active investing might be a good fit for you. Another situation where active investing might make sense is if you have a specific goal in mind and want to be more hands-on with your investments. Passive investing involves purchasing low-cost, highly-efficient index funds and holding onto them for the long term. The more you understand the difference between active and passive investments, the better prepared you will be to make smart, informed decisions when it comes to growing your money.