Active vs. Passive Investing: It's Time to Understand the Difference Once and For All

By Paul McCoy, CIMA®, AIF®

Even with the onset of COVID-19, major online brokers saw new accounts grow as much as 170 percent in the first quarter of 2020.¹ For investors, whether working with an advisor or taking a DIY approach, it’s important to understand the fundamental differences between two common investing practices - active and passive. 

What Is Active Investing?

Some investors may look at active investing with a goal of “beating the market” and outperforming specific standard benchmarks. In order to do this, investors may follow investment trends and buy or sell as investments rise and fall.

Investment advisors may actively invest assets such as:

• Mutual funds
• Exchange-traded funds (ETFs)
• Portfolios of stocks, bonds and other holdings

The general idea surrounding active investing is that if things go well with your investments, you may be able to outperform the market, even including the fees you pay to your advisor or broker. Performance, however, is never guaranteed.

Active Investing Considerations

Stock Picking

If you’re working with an investment advisor or team of advisors, a person (or team of analysts) may be picking individual stocks or sectors of the market to invest in.

Fees vs. Performance

Having an advisor or advisory firm actively manage your portfolio can incur higher fees than those who follow a passive investment strategy. Because of this, an investor would want to beat the market by a certain percentage in order to make paying the higher fees worth it in the long-run.

What Is Passive Investing?

By practicing passive investing, you aim to maximize your returns while minimizing the amount of buying and selling that you do. With this strategy, investors may buy and hold their stocks and bonds in passive funds or passive index funds.

These funds rise and fall to match the performance of certain indexes. Because of this, passive investments are not meant to beat or outperform the market, but rather match the market’s performance.

Passive Investing Considerations

Potentially Lower Fees

Because passive funds don’t have such a hands-on human component to them, they tend to incur fewer fees than active investments.

Transparency

An investor will know exactly what stocks or bonds their indexed investment contains. For some, this transparency and consistency may be comforting or reassuring to know as they work toward their long-term financial goals.

Which Is Right For Me?

Some investors may find a mix of both active and passive investments the right move for diversifying their portfolio. With the lower fees passive investments tend to incur, it may be an appealing option for investors who don’t have the time or desire to actively manage their investments or can’t hire someone to do it for them.

How you choose to invest will likely come down to your priorities, desired personal involvement and long-term goals. If you’re unsure what direction to take your investments, an investment advisor can help explain your options and provide further guidance.