Active and Passive Investing Strategies

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:

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.

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