What are active investing strategies?
Active investing is a high-risk, high-return investment strategy that involves frequent buying and selling activities intending to beat the market. This approach is in contrast to passive investing, a low-risk, long-term investment strategy that aims to match market returns by investing in a diversified portfolio and holding investments for an extended period.
Active investing involves a hands-on approach that requires a portfolio manager to make decisions regarding investment selection, allocation, and rebalancing as per market fervour. The portfolio manager may use various investment tools, such as fundamental and technical analysis, to identify undervalued stocks or to predict market trends. The goal is to outperform the market and generate high returns for investors.
One of the main drawbacks or rather challenges of active investing is its high costs, including operating expenses, due to the high volume of transactions involved, and capital gains taxes. In addition, the portfolio manager’s decisions may not always result in profitable outcomes, leading to potential losses for investors. The basis for this strategy is – the higher the risk, the higher the returns.
What are passive investing strategies?
Passive investing is a long-term investment strategy that works on a buy-and-hold model to maximise returns. The objective is to build wealth over a longer duration by buying securities that mirror market indexes and holding them for an extended period.
It is based on the idea that the market’s rise will provide gains for those who wait, and it is a popular way to compound wealth without making multiple buy and sell decisions on individual stocks or securities. Passive investing can lower risk, especially when investing in well-diversified portfolios like index funds.
One popular way to take advantage of the passive strategy is to buy index funds, which offer diversification, low costs, and broad exposure to the market. Regular purchases are made, and time does the rest. It is a more tax-efficient strategy for wealthy investors to grow their corpus in a safer investment that is equity-linked.
Passive investing offers several advantages over active investing, including lower costs, reduced trading volumes, and greater tax efficiency. With passive investing, investors can focus on their long-term goals and avoid the volatility and risks of active investing.
Active vs. passive investing strategies
The table below illustrates the differences between active and passive investing strategies.
|Parameters||Active strategies||Passive strategies|
|Strategy||The fund manager actively changes the composition of funds at their discretion.||The fund manager only tries to mirror the movement of the benchmark indices.|
|Purpose||Active investment strategies are adopted to earn short-term profits.||Passive investment strategies are adopted to earn long-term profits.|
|Returns||The fund manager is often able to beat the benchmark.||The returns are at par with the benchmark.|
|Expense ratio||0.08% to 2.25% depending on equity or debt orientation||Maximum 1%|
|Flexibility||Active funds are not limited to a particular index.||Passive funds are limited to a particular index with little to no flexibility.|
|Costs||Incur higher fees||The reduced trading volumes result in lower fees for investors.|
|Risk||These are highly volatile. However, investors can minimize the risk by diversifying their investment portfolios with different assets.||These are not as volatile as active funds.|
|Returns||High risks generate higher returns||Low risks generate lower returns|
Active and Passive Investing Strategies – Which one’s right for you?
Investing in the stock market can be daunting, and choosing between active and passive investing strategies can be overwhelming for new investors. The right strategy depends on financial goals, investment style, and risk tolerance.
Here are some factors you should consider when deciding between active and passive investing strategies:
- Cost: One of the primary advantages of passive investing is lower costs. Passive investors generally pay lower fees than active investors because of the reduced trading volumes associated with passive investing. If you’re planning to invest long-term and keep costs low, passive investing could be the right strategy for you.
- Risk management: Active investors can manage their risk exposure. It’s done by selling or avoiding certain holdings and market segments, unlike passive investors, whose portfolios depend on the market. Therefore, active investing could be a better choice if you want more control over your investments’ risk.
- Time commitment: Active investing requires more time and effort than passive investing. Passive investing could be the right fit if you have a busy schedule or prefer a hands-off approach. On the other hand, if you enjoy staying up to date with the markets and are willing to put in the time to research and monitor your investments actively, then active investing may be more suitable.
- Investment goals: Your investment goals should also be taken into consideration. Passive investing could be the right choice if your goal is to achieve long-term, steady returns. However, active investing might be more appropriate if you’re willing to take on more risk for potentially higher returns.
The choice between active and passive investing strategies depends on investors’ risk tolerance, investment goals, and personal preferences. Both approaches have pros and cons, and a blended approach combining both strategies can be a suitable option for investors who want to diversify their portfolios and maximize their returns. Regardless of the strategy, it is crucial to do thorough research and seek professional advice before investing in the stock market.