The ongoing debate between investors and advisors regarding active versus passive investing has been reignited amid a market downturn attributed to rising interest rates over the past year.
Passive investing involves aiming for average market returns by holding onto investments for an extended period, allowing investors to weather market fluctuations. On the other hand, active investing seeks to outperform the market, relying on more frequent buying and selling. As the markets experience a decline, the desire for outperformance becomes increasingly appealing to many investors.
Each approach presents distinct advantages and potential drawbacks.
Active Investing Explained: Active investors take a hands-on approach, striving to outperform specific benchmarks such as the S&P 500 Index. This method involves closely monitoring companies and executing trades to capitalize on short-term price fluctuations. While investors can undertake active investing themselves, its complexity and the need for high-level market analysis make it less suitable for novice investors.
Alternatively, investors may opt for actively managed funds where experienced fund managers leverage their market insights and conduct in-depth research to determine optimal buying and selling times, aiming to maximize returns. Working directly with a portfolio manager or financial advisor is another avenue, allowing for customized index building through direct indexing. However, the hands-on approach of active investing is often associated with higher fees, impacting overall returns.
Passive Investing Defined: Passive investing adopts a long-term mindset, emphasizing the purchase of assets regardless of daily market fluctuations, with the intention of holding them for an extended period. This strategy commonly involves investing in exchange-traded funds (ETFs) or index funds that replicate market indices while minimizing buying and selling. The hands-off nature of passive investing reduces the need for constant attention and extensive research, resulting in lower costs and potentially allowing investors to retain a larger portion of their returns.
Choosing the Right Approach: Determining the ideal approach—active or passive—depends on various factors, including individual goals, time horizon, and risk tolerance. Those willing to pay higher fees for the potential of outperforming the market might find active investing suitable. Conversely, passive investing may be more aligned with long-term goals, such as retirement.
It’s essential to recognize that the investment approach doesn’t have to be an all-or-nothing decision. A balanced portfolio may include both active and passive investments. Seeking advice from a Wealth Advisor can help strike the right mix, aligning short-term and long-term goals and ensuring a well-rounded investment strategy.
Sources: https://www.tiaa.org/public/invest/services/wealth-management/perspectives/considering-active-vs-passive-investment-management https://www.federalreserve.gov/econres/feds/files/2018060r1pap.pdf https://www.bis.org/publ/qtrpdf/r_qt1803j.htm
