Active v Passive Investing

What's the difference?

So, you’ve decided to build up a financial plan for the future, and that involves an investment strategy. There are two principal ways to invest, either passively or actively. Here we explore the benefits and negatives of embarking on either route, and hopefully find the right direction for you.

ACTIVE INVESTMENT

Active investing, which is not to be confused with activist investing that tries to force a company’s hands by taking a position in it, is essentially a hands-on approach where a portfolio is actively managed. In simple terms what this means is that somebody, whether you or a professional fund manager, is deciding on a day-by-day basis what they should buy and sell. The goal of active investment is simple: to beat the stock market’s average returns, known as the benchmark, by taking advantage of in-depth knowledge and analysis.

A fund manager will work with you to decide on what your objectives might be for your portfolio. Typically, in today’s market there are five different sets of parameters that managers work to and will be set out in an investment mandate. These range from low risk cash equivalent returns where capital preservation is a key concern, to an equity-led portfolio where returns (and losses) can be considerably higher. Success often depends on the manager or firm you employ to advise you to pick stocks. They need to constantly assess qualitative and quantitative factors and have the expertise to know when to pivot in and out of a particular asset or asset class. This continuous action is what gives active investment its name.

PASSIVE INVESTMENT

Passive investment is a much simpler way of working, and requires very little human interaction once set up, and doesn’t require the investor to anticipate every move within the stock market, relying less on the competence and expertise of a fund manager.

A passive approach typically includes investing in an index tracking fund or an exchange traded fund (ETF). An index tracking fund is designed to track a particular index, for example the FTSE 100, while an ETF bundles up a group of securities that can track particular market sectors (agri-tech, AI, bio-tech etc) or different assets (bonds, commodities, currency etc). These index funds or ETFs will be a microcosm of the market and are managed and run as a whole, so day-to-day trading will be negated. There will of course be winners and losers within the fund, but these tend to balance themselves out. The key though is of course selecting the right funds to invest your money in. Once again, this is where expert knowledge of the underlying markets and investments comes in.

 

WHICH IS RIGHT FOR YOU?

The first and perhaps the most obvious advantage of a passive investment strategy over an active one is the cost. Passive investment tends to be cheaper and limited to the trading cost of buying into the particular fund. With active investment, there is typically a fee of anywhere from 1-2% paid to your fund manager, as they need to cover the expense of their time, analysts and infrastructure.

The minimum amount required to invest actively is also generally higher, as many active fund managers will need a substantial portfolio to generate the right returns for both parties, as well as accessing the underlying investments themselves. When investing passively, be it through an index fund or an ETF there isn’t usually a minimum amount.

Active investments, once set up, offer a higher level of control and ability to manoeuvre quickly in the market, exiting a sector or asset class when they spot trouble looming ahead, or are able to pivot quickly into a new asset class to reap rewards. It is important to realise that investment is a long-term activity, whether passively or actively. Markets are cyclical and while portfolios tend to rise if you take the long view, they also spend months, or sometimes years, in the doldrums before slowly rebuilding. The key here though is to keep that long-term outlook in mind, and remain invested.

Whether you are investing passively, actively, or opt for a combination of both, doing in funds or ETFs allows you the opportunity to spread the risk across multiple markets, assets and industries. In other words not having all your eggs in one basket. This diversity can act as a safety net, sometimes curtailing the worst of the markets’ mishaps.

Whichever direction you chose make sure you do your due diligence first to find the right funds or right advisors to invest with. Your investments with Silo are managed by the award-winning team at Killik & Co, who have been investing on behalf of their clients for over three decades, so you know you are in expert hands.

After all, this is your future we’re talking about.

 

Please note this article is for information purposes only and is not personal advice. As is the nature of investing, your capital is at risk.