Active vs Passive Investing: Which Style Suits you?

By  //  June 30, 2022

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Poland has become the sixth largest economy in the European Union after Brexit. Yet with the cost-of-living surging at home and beyond, many people will be looking for ways to make their money go further right now. 

Investing is often seen as the smartest way to make your savings grow. But with a variety of different strategies and tactics out there, it can be difficult to know where to start. 

Two such strategies are active and passive investing. As the names suggest, they represent contrasting approaches, both of which have their pros and cons for different people. Below, we’ve summarised the two to help you hone your ideal investing style.  

Pros and cons of active investing

Active investing describes frequent trading activity, typically on individual securities, usually with the aim of beating index returns. It’s what you might think of when imagining professional traders on busy shop floors in New York or London, though you can sign up for a trading app from your smartphone too.

Key advantages include flexibility to act quickly in volatile markets, diverse trading options such as hedging or shorting stock, and the potential for tax-loss harvesting. 

Downsides however are the likelihood of higher fees due to frequent transactions and high levels of management, increased risk of significant losses if a single stock crashes, and the pitfalls of trend-based investing. 

Pros and cons of passive investing

Passive investing is a strategy of buying and holding assets through ups and downs with longer-term goals in mind, like education fees or retirement. Rather than focusing on individual assets, passive investors tend to buy shares of index funds or ETFs.    

Two important advantages of passive investing are the lower levels of attention needed, and lower associated costs – such as transaction and management fees – as a result. Plus, by investing in funds of many stocks, you’ll reduce the risk of one bad stock wiping out your investment. 

At the same time, passive investing is a long game, and can seem dull to some investors. This also means it’s harder – or at least slower – to get out or recover returns when a market dips.     

Active vs passive investing example

It is the understanding of a great number of investors that using both styles of investing can be successful in minimizing stock portfolio damage during unstable periods. Blending the two is a good way to diversify a portfolio and proven way against mitigating the overall risk. 

Investors who own a lot of cash might want to consider for an active investment in ETFs right after the market has pulled back. Retirees usually think about income first and may actively go for particular stocks that provide dividend growth, thus keeping the buy-and-hold mentality (dividends are what companies give as cash to investors who own their stock). 

It’s important to notice that not just returns matter, but the risk-adjusted returns. These can be defined as the amount of profit from a particular investment while taking into account the level of risk that was involved in getting the return. An important part of investing is controlling how much money will be put into a particular sector or a specific company when the market conditions are rapidly changing, so that the investor is protected. 

It is suitable for the majority of people to use both types of investing during their lifetime in order to secure comfortable retirement, for example, or other key goals in life. That’s why many advisors will often combine both strategies. 

Combining both strategies

Blending the two strategies may offer you the best returns. This is because active strategies tend to perform better in certain investing climates, like volatile markets or weakening economies, while passive strategies can be the right option in other scenarios, like when securities are moving in correlation with each other. 

Smart investors will look for relevant opportunities for both approaches while keeping a close eye on market conditions. That said, if you have specific priorities like reducing your trading costs, then one approach – in that case passive investing – will suit your objectives better. 

Ultimately, it comes down to your own investment goals and timelines and how you think your money can serve you best.