Active vs. Passive Management

fortpitt in Investments 27 August, 2021

When choosing how to invest their assets, investors can choose one of two main strategies: active management or passive management. These strategies are very different and may result in vastly different investment performances. Understanding the difference can be crucial to picking the right strategy based on your circumstances, needs, and risk tolerance.

What Is Active Management?

Active management is a technique where your portfolio performance is constantly being monitored to attempt to outperform the market through various investments. These techniques may have high turnover and often follow market trends. Active managers constantly make buy, sell, and hold decisions on securities based on their analyses, forecasts, research, and experience.

What Is Passive Management?

On the other hand, passive management is a technique where the portfolio uses a buy-and-hold strategy or an index strategy. It is often used when an investor is buying mutual or exchange-traded funds. This technique limits portfolio turnover and typically attempts to mirror a benchmark such as the S&P 500. Passive management does not attempt to outperform the market but tries to generate the market return year after year.

Active Management Investment Philosophy

When choosing an active strategy, investors should be aware that trading costs such as taxes and transactions fees will typically be higher. However, not all active strategies are constantly trading and keeping up with the latest trends. There are active strategies that tend to be more passive. In this case, managers pick certain investments they believe will outperform the market over a longer time period and then utilize a buy-and-hold strategy. This is considered an active strategy because the manager is still trying to outperform the market over the long term. With active management, there is a lot greater flexibility with what your portfolio is invested in as well. However, it is very hard for active managers to consistently beat the market over time.

Passive Management Investment Philosophy

Passive strategies, such as buying an index fund, experience very little turnover. Fees for this strategy are also typically lower than with active strategies. Passive strategies, by design, typically underperform the market by the amount of their fees. There also are not nearly as many investment options for passive strategies. However, for investors who are looking for returns consistent with the overall market, passive strategies are the way to go.

Should You Choose Active or Passive Management?

In general, the choice to go with an active or passive strategy is based on how much risk an investor is willing to accept. For the same type of investment (i.e., equities), active strategies are riskier. In contrast, passive strategies are generally thought of as safer. Investors can also utilize both strategies to diversify their portfolios further. Seeking out professional advice can help investors make the best decisions with their money.

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