The Difference between Active Investing and Passive Investing
Just one generation ago, investing was costly and limited. Fast forward to today, markets and investment products had grown and developed so much, creating opportunities for regular families to invest, as passive investing grew more popular both in Australia and overseas. Now, passive investing may sound counter-intuitive, can you really be passive for something as important as investing?
There are two types of investing. People are more familiar with traditional “active” investing, which conventionally involves investment specialists closely monitoring markets and buying and selling shares with the aim to try outperform the overall returns of the stock market. Passive investing takes out the human element of having to decide what to own and when to own it, instead, it is driven by a set of rules which determines investment decisions. Instead of trying to “beat the market”, a passive investment will aim to track the market. For example, a passive fund might track the ASX200, which means they effectively own a piece of the top 200 stocks listed on the Australian Stock Exchange. So whatever the ASX200 returns is what the fund will return. Effectively you “own the market” with this type of fund.
What do “owning the market” means?
Now, “owning the market” means owning a little piece of the whole thing, this is made possible by Exchange Traded Funds, or ETFs. An ETF is an investment account that is traded on the stock exchange, and investors can buy shares in the fund. For instance, an ETF that owns the top 200 stocks on the Australian sharemarket can sell its share to an investor, thus granting the investor exposure to 200 stocks without having to buy the heap. As the stock market continues to move, the fund will buy and sell accordingly.
Passive owning or even following the market has been a trend in recent years. It allows exposure to a wide range of assets at a cheaper price than heaps of active funds because when you don’t try to beat the market there would be no need for a full workforce of investment analysts and you overall trading costs and tax costs are lower. On the other hand, a passive approach only watches the market, so, it would not achieve returns more than what the market can offer. Additionally, if the market stumbles, a passive approach cannot avoid it, nor prepare for it, which an active approach can do.
Conclusion
Well, at the end of the day, instead of sticking to either an active or passive approach, we believe that the benefits and costs vary differently amongst investors. The best way to confront the question on which to choose is to explore the investor’s current situation, before anything else. Both of these initiatives are crucial tools of wealth creation, and for that reason, it would be best to find a very good financial adviser, which you trust then consult before you decide which way to go.