Active vs passive investing: Pros and Cons
Active and passive investments are very different ways of investing and both come with pros and cons.
All investing has the same goal of building your wealth. There are different ways to get there though. Passive investing aims to follow the performance of either the overall market, or certain sections of it. Active investing relies on experts to manage things with the aim of giving you higher returns. But which is for you? We’ll explain the benefits and drawbacks here, so you can decide which suits you best.
Whether active or passive, investments can fall as well as rise and you may get back less than you've paid in.
What is Active Investing?
Fund managers are the key to active investing. They're employed to oversee an investment fund, using their knowledge to buy and sell the investments that make it up.
This involves detailed research on individual companies – like new products they’re creating, how their business fits with current trends in the overall economy and their senior management. For example, a company may have a new drug in the pipeline that could become a market leader, which would see their share price increase fast. A fund manager would aim to buy that company’s shares before they go up. They also look at wider things that could affect investments, like political changes and conflicts. Managers can act to sell shares if a company isn’t performing well, to try cut losses in the fund.
Pros of Active Investing
The biggest appeal of active investing is that fund managers aim to get higher returns than funds which track an index.
Fund managers also have the freedom to choose investments that make up the fund and the size of each one.
This lets them make changes quickly, which can help reduce losses if something like a market crash happens. For example, if a fund has a high percentage of company shares, the fund manager can sell some of them and move the money into safer investments like bonds or just hold more cash.
Cons of Active Investing
Using the expertise of a fund manager comes at a cost and actively managed funds will usually have higher fees than passive ones. This can cut into your profits and reduce the growth of your money over time.
You’re also relying on the fund manager’s strategy to outperform the market. This can mean taking bigger risks and any poor choices can harm your returns. It can be a bigger issue during downturns if the manager stays invested in companies which are more affected. The fund’s performance may also drop if a successful manager leaves, and another takes over.
Trying an active investment strategy without using a fund manager can also be very time consuming and difficult for a novice investor as it requires constant monitoring of your investments and lots of research.
What is Passive Investing?
Passive investing looks to match the performance of a market index like the FTSE 100 or S&P 500. It does this by creating funds that hold investments like shares or bonds in lots of companies that make up an index, and keeping buying and selling to a minimum. When the index rises, the investments in the fund should rise to match it.
Pros of Passive Investing
As they require less management and don’t trade investments as often as fund managers, passive funds will generally have lower charges than actively managed ones, which means investors keep more of any gains. As they only aim to track an index they can be less risky than actively managed funds where a manager is aiming to outperform the market, which can mean investing in companies or trends which may not succeed.
Cons of Passive Investing
Passive investing doesn't have the flexibility of active investing to change the balance of companies in a fund based on possible gains. For example, to invest heavily in a company that may have strong growth prospects.
Equally, when things are bad, investments in a passive fund won’t be sold or switched in reaction to any downturns, so investors will have to ride them out with the market.
Comparing Active and Passive Investing
| Active | Passive | |
|---|---|---|
| Cost | Higher fees to cover the cost of managing the fund. | Lower fees as the fund tracks the market, needing less management. |
| Goals | Aims to achieve higher returns than the overall market or a section of it e.g. Technology. | Aims to deliver returns that match increases in an index covering part or all of the market. E.g. the Nasdaq technology index. |
| Best for | Investors looking for higher returns, who are happy to rely on the performance of a fund manager | Investors looking for steady growth over a long period. |
Which Strategy is Right for You?
It all comes down to personal choice. If you’re hoping to get higher returns than the overall market and don’t mind higher fees and maybe higher risks by putting your trust in a fund manager, then active investing may suit you better.
If you’re happier to track the market in a way that has a lower cost, and you can sit back knowing your investments are likely to experience some ups and downs with the overall market, then passive investing may suit you better.
If you’d like to learn more about investing, you can check out the products Aviva offer.
With either route, investing works best over at least five years. The value of any investments can fall as well as rise, and you may get back less than you’ve put in.
If you’re not sure whether investing is right for you, or want advice on passive or active choices then we’d recommend speaking to a financial adviser – there will usually be a charge for advice.
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