Your investing strategy is a personal approach based on your goals, life stage and risk tolerance. What’s right for your friend, coworker or neighbor might not be the best strategy for you. There are so many different ways to invest, but two of the most common methods you’ll find are active and passive investing.
There are upsides and drawbacks to both, so it’s important that you understand the full picture of each before you adopt one as an investing strategy.
What is active investing?
Active investing involves a hands-on approach to managing your portfolio. Active investors tend to hand-pick stocks, bonds or other securities that have growth potential, and sell off the ones that don’t. They spend time researching undervalued or up-and-coming investment opportunities, and watch the markets closely.
Oftentimes, the goal with active investing is to time (and beat) the market. There are a few upsides to this approach. If you are a skilled investor and well-versed in market fluctuations, you may be able to capitalize on quick opportunities, or sell off a security before your portfolio takes a hit.
However, there are some significant downsides to using an active investing approach. For one thing, no one can really time the market. The markets are fickle, and prone to quick swings based on even seemingly minor events.
Another problem is that there are fees associated with buying and selling in the markets. Transaction fees, management fees, and capital gains taxes can eat into your returns. Actively managed mutual funds also have more expensive internal fees, which take away from your overall returns.
And finally, active investing requires more of a time commitment than most people are willing, or able, to give. Markets change daily, and staying on top of them can be a tall order.
What is passive investing?
Passive investing is just what it sounds like: you invest in a way that tries to track the market’s returns over time. For many investors, they opt for index mutual funds or exchange-traded funds (ETFs) that track a specific market index, like the S&P 500.
The perks to a passive investing approach is that it’s a more feasible way for the average person to build wealth over time. The fees and time commitment are low, and your portfolio is diversified to weather the ups and downs of the market.
There are some downsides, like less flexibility, and less ability to take advantage of quick opportunities in the market. It also means that when the market is down, your portfolio may be down with it. But the idea is that as the market goes back up, your portfolio is designed to rebound with it.
Active vs. Passive Investing: What does the data say?
We have decades of data on market and portfolio performance, and in the vast majority of cases, passive investing outpaces more active approaches. For example, research from S&P Global found that over the 20-year period ending in 2022, only about 4.1% of professionally managed portfolios in the U.S. consistently outperformed benchmarks.
There are exceptions, of course. But in general, the lower fees and more consistent performance makes passive investing a better option for the average investor.
Which investing approach is right for you?
Deciding how to invest is going to depend on several factors, including:
- Personal goals – Are you looking to build a passive portfolio that supports long-term, steady growth without much interference? Or do you want to create a customized portfolio that you will actively monitor and change more frequently?
- Risk tolerance – How comfortable are you with risk? If you are more risk averse, then an active approach to investing might be too stressful for you.
- Knowledge and time commitment – Are you willing to put in the time and effort it takes to understand the nuances of active investing? Or do you prefer a set-it-and-forget it approach?
The decision to be an active or passive investor is, ultimately, up to you. But you don’t have to choose one or the other entirely. If you want to create a passive portfolio but still enjoy the excitement of active investing, you can set aside “fun money” that won’t have a significant impact on the performance of your portfolio. That way, you can still participate in the newest investing trends and opportunities without missing out on the steady returns that come from long term investing.
Whichever approach you choose, make sure it aligns with your goals and needs, and work with a professional if you need more help building the right portfolio for you.
About Your Richest Life
At Your Richest Life, Katie Brewer, CFP®, believes you too should have access to financial resources and fee-only financial planning. For more information on the services offered, contact Katie today.
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