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Active Investing vs Passive Investing

09 Dec 2022 0 COMMENT

Introduction

Investment portfolios can be managed either actively or passively. Investors experienced in the stock market often prefer an active investment strategy to beat the benchmark. However, passive investors focus on duplicating the benchmark performance and aim for long-term stable returns.

Active Investing

Active investing implies active management of funds with the main aim of maximising returns. In active investment, the traders employ multiple techniques to know when to enter or exit the market. The strategy requires high-level market expertise and analysis to determine when to buy or sell the assets. It needs a hands-on approach to beat the average market returns. An example of active investing is an equity mutual fund where the fund manager decides which funds will go in and out of the fund.

Advantages of active investing

  • Active investing allows you to test your market skills.
  • Active investment strategy offers you the flexibility to make decisions. You can invest in government bonds or cash during high volatility to prevent losses. On the other hand, more equity investments can be made in a growing market.
  • Highly experienced investors or professionals can use suitable trading techniques to maximise returns.
  • Active investing can result in losses if the decisions are not proven right.
  • If you are independently managing your portfolio, it is difficult to beat professional active traders.
  • To benefit from the expertise of fund managers, you have to pay charges in the form of expense ratio.

Disadvantages of active investing

Passive Investing

Contrary to active investing, passive investing involves a long-term approach to holding investments. While passive investing can be used in any financial instrument, the most common passive investing method is an index. Passive investors usually buy an index fund to avoid constant analysis of individual assets. The investment strategy aims to generate stable index returns instead of outperforming the index. An example of a passively managed fund is an exchange-traded fund. In an ETF, the fund tracks the index’s movement set by NSE or BSE, where the investor has nothing to do with what goes in and out. By investing in an index or benchmark, the investors hold the investment for a long duration without tempting to anticipate or react to the market’s moves. With limited buying and selling of assets, passive investing is a cost-effective strategy.

Advantages of Passive investing

  • Passive investing leads to low costs for individual investors due to less trading volume.
  • Passively managed funds charge low expense ratio than active investing as they require less research and tracking.
  • The investment strategy comes with low risk and adequate diversification.
  • There is no pressure to outperform the market’s average returns in passive investing.
  • With no need for constant tracking, passive investing requires minimal time.
  • Usually, long-term passive funds offer higher average returns than actively managed funds.
  • The funds in passive investing are limited and are locked in for the long term.
  • Passive funds offer less flexibility and no exit strategy during market volatility.

Disadvantages of passive investing 

Active vs Passive Investing

Basis of Difference

Active Investing

Passive Investing

Investment Strategy

Buy and sell

 

Buy and hold

 

Monitoring

Need constant monitoring with a hands-on approach

No need for a constant monitoring 

Expense Ratio

Higher

Lower

Fund Management

Actively managed

Passively managed

Risk

High risk

Comparatively low risk

Flexibility

More flexible

Less flexible

 

Active vs Passive Investing: What to choose?

The choice between the two strategies is based on how much time you wish to invest in the market, the risk you are willing to take, and the market expertise you hold. Active investing is better if you like spending time in the market and willing to take more risks for the sake of higher returns. On the other hand, you can opt for passive investing if your priority is stable returns over time and you do not wish to invest much time in the market. However, it is possible to use both strategies simultaneously. You can choose to buy and hold a certain percentage of index funds and a few actively traded stocks in your portfolio to benefit from both approaches.

Conclusion

Now you know what is active and passive investing. Both strategies have their own set of pros and cons. However, passive investing works better for most investors. However, it is essential to do your own research and choose what works best for you. You must evaluate the risk associated with both strategies, their expense ratios, flexibility and returns before opting for any particular approach.

Disclaimer: ICICI Securities Ltd. (I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. I-Sec is a Member of National Stock Exchange of India Ltd (Member Code :07730), BSE Ltd (Member Code :103) and Member of Multi Commodity Exchange of India Ltd. (Member Code: 56250) and having SEBI registration no. INZ000183631. Name of the Compliance officer (broking): Ms. Mamta Shetty, Contact number: 022-40701022, E-mail address: complianceofficer@icicisecurities.com. Investments in securities markets are subject to market risks, read all the related documents carefully before investing. The contents herein above shall not be considered as an invitation or persuasion to trade or invest. I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investors should consult their financial advisers whether the product is suitable for them before taking any decision. The contents herein mentioned are solely for informational and educational purpose.