What Is the Difference Between Active and Passive Investing?

What Is the Difference Between Active and Passive Investing?

Investing in the broader sense is often categorized as either active investing or passive investing. This article will discuss the advantages of both types so you can make an informed decision on what is best for you.

What Is Active Investing?

Active investing is where the investor or portfolio manager are very hands-on in monitoring the investment. The purpose is to profit from short-term market fluctuations. Active investing requires expertise and close monitoring to be able to analyze the fluctuations and try to time them for maximum profit.

Active investing is only beneficial if the portfolio manager can beat the stock market, which requires them to be right about stock movements more often than they are wrong. A portfolio manager will work with analysts who look at the numbers of the company and the stock market and try to predict the movements of the stock.

What Are the Advantages of Active Investing?

· Tax management – One of the disadvantages of active investing is having to pay tax on the profits. However, a prudent portfolio manager will be able to reduce the tax implications through a number of tactics. A common tactic is to sell off underperforming stock to offset the taxes on high-performing stock.

· Hedging – Managers of active investment portfolios can use strategies to minimize the risk of certain stocks. They do this using techniques like selling a stock short to allow them to exit when the risk becomes too great.

· Flexibility – An active portfolio isn’t tied to indexes; this allows portfolio managers to buy and sell individual stocks. They can find opportunities in the marker that they think will bring successful outcomes.  

What Is Passive Investing?

Passive investing focuses on the long-term profitability of the investment. The strategy is often to buy and hold rather than reacting to the fluctuations of the stock market. Because there are fewer transactions being made in a passive investment portfolio, it attracts less fees. Many passive investors will buy shares in index funds that track the movements of Dow Jones or the S&P 500.The index funds will buy and sell their holdings based on the changes in the major indices without the investor having to buy and sell stocks.  A passive investor earns their returns in the long-term with the growth of the stock market. Economic downturn and short-term market fluctuations do little to affect the overall profit.

What Are the Advantages of Passive Investing?

· Tax efficiency – Capital gains tax is only applied after the investments are sold.Therefore, there is unlikely to be any significant yearly tax implications.

· Low fees – A passive investment portfolio is less hands-on, so it doesn’t attract costly management fees. Also, due to the buy and hold strategy behind passive investing, they do not attract as many transaction fees.

· Transparency – A passive investing portfolio will typically follow indexes; therefore, it is very clear what stocks are held in the fund.

Which Should I Choose?

Passive investing and active investing both have benefits depending on your timeline and overall investment goals. If you choose active investing, you should ensure you have full confidence in your portfolio manager. Some investors include a mixture of both in their overall investment strategy.

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