You’ve worked hard, you’ve been putting money aside but now you’re tired of seeing it slowly accumulate, or worse, go down in value as it sits idle in your account. You want to invest but that can mean a million and one things – max out your ISA allowance? Take up an interest in Bitcoin? Look for an entrepreneur with a game changing idea?
When you’re looking for your first investment opportunity and deciding on the next step in your investment strategy, the first thing is to decide between passive investing vs active investing.
Here we look at active vs passive investing, what are the differences and pros and cons of both of each style.
What is active investing?
Active investing is when you invest in funds where portfolio managers select the component investments for you based on an independent assessment of their worth. It essentially means taking time to research your investments and constructing and maintaining your portfolio, either on your own or through a fund manager.
Active investments tend to be based on short-term performance and the aim is to beat average market returns. This approach allows money managers to adjust investors’ portfolios to align with prevailing market conditions. In essence, active investing is as it sounds – it involves proactive involvement rather than putting your money into the investment and letting it do its thing over time.
Types of active investment strategy
There are lots of ways to define investment types, but in the context of equity, shares and funds, active investment can broadly be divided into two categories:
- Fundamental (also known as discretionary): This focuses on human judgement to choose your investments – perhaps you choose them, or your fund manager does.
- Quantitative (also known as rules-based): This is where quantitative models are used to select investments, including risk analytics, and portfolio optimisation.
Within your active investment strategy, you may then take one of the following approaches:
- Bottom-up – based on value and growth.
- Top-down – based on the macroeconomic environment.
- Factor-based – when you look at a set of characteristics because of particular knowledge you may have (price momentum, value, etc).
- Activist – when you take a meaningful stake in a listed company that can influence its value.
Benefits of active investing
- Active investment funds tend to be more flexible than their passive counterparts.
- You can hedge your bets by using short sales, placing options and other strategies.
- Active investment can bring bigger returns than passive investment.
- They can deliver performance that beats the market over time, even after their fees are paid.
- You can manage your risk by selling specific holdings quickly when the stakes get too high or you deem appropriate.
- You can manage your tax with strategies such as offsetting taxes from money-losing investments against winning stocks.
- There’s potential to benefit from mispriced opportunities in the market.
Risks of active investing
- There are often high management fees, especially if you go through a recommended advisor, and investments need to perform well to make that worthwhile.
- Active investment comes with greater risks than passive investment.
- There’s no guarantee an active fund will be able to deliver index-beating performance and many don’t.
- Fund managers are human and they don’t always get things right, which can be expensive.
What is passive investing?
Passive investing or passive funds are often preferred by investors who are looking at a long-term strategy. It’s generally considered to be lower risk, depending on the details of your approach, but that doesn’t mean it’s for beginners. On the contrary, finance oligarch, Warren Buffett, has famously been a proponent of a passive investment strategy, believing in the long-term efficiency and lower costs that they can yield.
The principle is summed up in his quote: “If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.” To explain, passive funds track the performance of the market or index that you’re looking at (e.g., the FTSE 100 or the Standard & Poor’s 500). They can be funds that track the broad market or narrow sectors, depending on your appetite for risk, your personal interests and your knowledge.
Types of passive investment strategy
Passive investment funds can include open-ended investment companies (OEICs), stock market listed exchange traded funds (ETFs) and more. However, the common theme is that it’s about buying and holding a portfolio for the long-term with minimal trading. Within that, you can select your investments based on different factors, such as the value of the dividends they pay, sticking to the 100 largest listed firms (I.e., the FTSE 100 in the UK), and you can opt for an established fund or build your own portfolio, usually through a fund manager.
Benefits of passive investing
- It’s a low-cost way of gaining exposure to certain assets/industries.
- It’s less complicated.
- There’s generally less risk, especially if you opt for funds at the top end of the market.
- It’s a solid and established medium- to long-term way of building moderate wealth.
- They generally perform closer to the index.
- Typically more tax-efficient.
Risks of passive investing
- More of a con than a risk, but there’s no opportunity to outperform the market.
- You still participate in the downside of the market.
- You buy and sell based on the index rather than personal research, which gives you less direct control.
How to start – whether you’re active vs passive investing
Whether you choose to pursue an active investment strategy or a passive investment strategy, you need to start by deciding what your goals are. Here’s a guideline for how to start:
- Don’t begin by thinking about the number you want to put in but what you’re investing for. That might be for retirement, to pay the school fees or to build up a cash buffer, for example.
- Choose your investing style based on your risk tolerance and your goals.
- Take the time to do your research into the market, the funds and the companies you’re interested in.
- Speak with a dedicated wealth manager, like MHG Wealth, to help support you in your investment journey
- Choose an investment service.
- Decide whether you’re investing on a monthly basis or in a lump sum, and if/when you’re going to cap your capital investment.
- Get investing.
- Keep track of your investments to ascertain the rate of return and if you’ve opted for active investing, make sure you stay on top of what’s happening, building your market knowledge and reading news about the companies you’re invested in, so you know when to act.
If you would like to learn more about the MHG exclusive investment opportunities or speak with an experienced financial advisor, please contact us at MHG Wealth Management today.
