The Pros and Cons of Active vs. Passive Investing: Which is Right for You?
If you are planning to make investments and are not sure about the investment strategy to adopt, keep reading. You would broadly want to choose from two basic strategies of investment; Active Investment and Passive Investment. These are two opposite approaches for investing money in the market. The former aims to rapidly shift investments and use market fluctuations to their own benefit whereas passive investment is a comparatively more long-term approach.
Active investment focuses more on short-term profits and involves repetitive trading with the goal to surpass the index returns. Due to its frequent shift, active investment requires expertise of the professionals and a consecutive market analysis. All investor activities will be based on the right time to invest or pull-out investments. Since active investment plays a lot around market fluctuation, it is very risky and easy for the investment portfolio to get damaged and affect financial goals due to the losses.
Since active investments need research and are time consuming, chances are that you would like to outsource it to professionals who would keep a constant tab on the stock market fluctuations for you. For investments of such nature, the professionals need to gather quite an amount of data regarding the market and its trends. This information is useful to keep on shifting the asset allocation for maximum returns.
Below are some of the factors that show you both sides of the coin regarding active investment.
Pros of Active Investment
The biggest edge that active investors have is the ability to to hold or reallocate their investments whenever they want to. They have an option of either withholding their investments, that could be cash or government bonds, when the market is down to avoid losses. On the flip side, the investors have the authority to reallocate their resources when it gives them expected gains.
- Trading Options
Active investment gives the investor an authority to mold the trading market by controlling the future of investments and creating a hedge to beat the market index. Active investors have the ability to turn down any serious threats to their investments by investing that create a hedge against a crash, inflation or a spike of interest rates. They can also remove investments from their portfolio. This results in the best investment returns.
- Authority to Pull out Investments
Since investors make quick movements and shift their investment portfolio frequently, the freedom of pulling out their investments from situations that pose high threats so a hedge is created against any major losses.
- Tax Management
The frequent movement of investments enables the investor to balance high taxes with selling of certain investments from their portfolio. If some bonds or funds are underperforming, they can be sold off with the aim of high return investment.
Cons of Active Investment
While moving your investments in and out of your investment portfolio may be very liberating for the investor, additional costs should always be considered. Even if the bonds or funds are not very expensive as it is, the transaction and transfer costs may make the activity heavy on the pocket.
- High Risks
If the investments work well for your goals, then it’s good. However, if things do not go as planned, it can bring down your entire investment portfolio. The losses as they are might be high and will make the situation worse if the money invested was borrowed. Moreover, more frequently the investors move their investments, more prone they are to face risks of their investments underperforming.
- The need for Professional Expertise
Since active investments require constant updates on the marketing trends and a very sound monetary knowledge, investors might always require a professional to help them to do so. Only appropriate knowledge of wealth management will get the investor sufficient returns. If you decide against hiring a professional, then be ready to invest lots of time and research.
If you’re not willing to take up the strategy of active investment, chances are that passive investment is more your thing. Passive investment involves retaining investments for a longer time frame which is why you might not be interested in short-terms market fluctuations as they are of no use to the investor. The goal of passive investors would be to gradually gain wealth with time and match the market performance.
Passive investment is an opposite approach to what we’ve been talking about earlier in this blog and has its own benefits and downsides.
Pros of Passive Investment
- Lower Costs
Since investments are withheld for a longer time, there are no transaction costs every now and then. Moreover, investing with this strategy doesn’t need frequent research and keeping up with the trends, thus, the investor does not need to bear the costs of hiring a professional consultant.
- Delay Capital Gains Taxes
Since passive investors can hold their investments for a longer time, it is very easy for them to delay their taxes on capital gains. They can delay this payment till they decide to sell off their investments which prevents them from getting an annual high tax bill on their funds.
- Easy Investment
It is comparatively much easier for a passive investor to make investments than for an active investor. They don’t need to know the market trends or the history of bond fluctuations in order to invest. Instead, they can just invest and have ample time to give their investment to mature and gain returns.
- Minimum Time Requirement
Unlike active investments, when you opt to invest passively, you do not need to keep a constant tab on the market trends. You just need to check their performance now and then, especially while filing taxes and giving the rest of the time to other ventures.
- Only be Watchful of the Company’s Success
As discussed earlier, passive investors are more dependent on long term gains, the success of their investments rely on the overall health and performance of the company and not the sudden, short-term highs and lows induced by other investors. Thus, short term activities might not worry a passive investor as such.
Cons of Passive Investment
- Less Freedom to Exit the Market
As a passive investor, you may not be able to exit the market on short notices. When the performances of your investments are not as expected, you would be stuck in your investment portfolio and will not be able to change your asset allocation accordingly.
- Not a Full-time Task
If you are looking for a full-time job in creating an investment portfolio, then passive investment is not for you. It won’t give you enough work or the adrenaline rush of keeping up with the market trends and doing research. You could say that passive investment could comparatively be rather ‘boring’ to work on.
Both kinds of investments have their ups and downs which might balance off each other. All you need to do is to identify your needs and goals to pick the strategy that suits you the best.