What’s the difference between passive and active investing? Is one approach better than the other or can you combine the two?
Passive investing
Passive investing is where you put your money into a fund that tracks a stock market index, such as the FTSE 100. Typically known as ‘trackers’, these funds hold shares in all the companies listed in the index.
The advantage of these funds is the diversification you gain across a broad range of stocks, making them a less risky investment. In addition to this, the fees are generally lower than for active trading funds.
Another benefit of passive investing is that it is easily automated. Without having to dedicate time to find and buy individual stocks, you can just set up a monthly direct debit into your tracker and forget all about it.
This is great for people who want to create an investing habit or are not interested in researching stocks. Passive investing also suits people who just want to ‘buy and hold’, rather than constantly trade their stocks.
One potential downside is given the fund is tracking the market, it will only ever provide average returns. This means you won’t have the opportunity to ‘beat the market’, which you may get through active investing,
Active investing
Active investing is the process of finding stocks that you think will increase in value in the future. Active investors try to build a portfolio of hand-picked stocks they think will perform well.
With active investing, you have the potential to beat the market. On the flip side though, you could also make some bad bets and underperform the market.
The other thing to watch out for are trading costs. Every time you buy and sell a stock, you get charged a fee. So the more you trade, the more the fees will eat into your gains (or losses).
Active investors should also be aware of our strange human behaviours that make us so irrational things with our finances. Suk cost fallacies and over-confidence have caught many an experienced investor out in the past, and will continue to do so.
Active funds
If you like the sound of beating the market, without having to do all the in-depth research, you can always invest in an actively managed fund.
This means you can automatically pay into the fund each month and just let the fund manager determine the stocks to invest in.
Bear in mind though, an active fund does not guarantee you’ll beat the market. Also the management fees for active funds are typically much higher than they are for passive index funds. So unless the fund does well, you could be losing money.
Combining passive and active investing
Passive investing has become more and more popular over recent years. Especially as it allows people to invest without having to spend all their time researching and picking stocks.
But that may not be enough for everyone. So if you’re tempted to try and beat the market you could always have a mixture of the two approaches by investing the majority of your wealth passively and keeping a small ‘fun fund’ to invest actively.
Thanks for reading 🙂