Active vs. Passive Investing: Understanding the Difference

Even with the onset of COVID-19, major online brokers saw new accounts grow as much as 170 percent in the first quarter of 2020.¹ For investors, whether working with an advisor or investing on your own, it’s important for all investors to understand the differences between two common investing practices - active and passive investing. 

What Is Active Investing?

The common goal of active investing is to “beat the market” and outperforming specific standard benchmarks such as the S&P 500 or Dow Jones Industrial Average. In order to accomplish this, investors may follow investment trends and buy or sell as investments rise and fall.

Investment advisors may actively invest assets such as:

• Mutual funds
• Exchange-traded funds (ETFs)
• Portfolios of stocks, bonds and other holdings

The general idea surrounding active investing is that if things go well with your investments, you may be able to outperform the market, even after paying your advisor or broker fees. Performance, however, is never guaranteed.

Active Investing Considerations

Stock Picking

If you’re working with an investment advisor or team of advisors, a person (or team of analysts) may be picking individual stocks or sectors of the market to invest in.

Fees vs. Performance

Active investments tend to have higher fees than passive investments as it requires a more hands-on approach from an advisor or advisory firm to actively manage your portfolio. Because of this, investors are looking to beat the market by a certain percentage in order to make paying the higher fees worth it in the long-run.

What Is Passive Investing?

The goal of passive investing is to maximize your returns while minimizing the amount of buying and selling that you do. With this strategy, investors may buy and hold their stocks and bonds in passive funds or passive index funds.

Passive funds rise and fall to match the performance of certain indexes. Because of this, passive investments are not meant to beat or outperform the market, but rather stay consistent and match the market’s performance.

Passive Investing Considerations

Potentially Lower Fees

Passive investments tend to have lower fees than active investments as they do not have as much of a hands-on human component to them.

Transparency

An investor will know exactly what stocks or bonds their indexed investment contains. Transparency and consistency are important for many investors as it may be comforting or reassuring to know as they work toward their long-term financial goals.

Which Is Right For Me?

Some investors may find a mix of both active and passive investments the right move for diversifying their portfolio. However, passive investments may be an appealing option for investors who don't have the time or desire to constantly manage their investments or can't hire someone to do it for them as passive investments tend to have less fees than active investments.

All investors are different so how you choose to invest will likely come down to your priorities, desired personal involvement and long-term goals. If you’re unsure what direction to take your investments, talking with an investment advisor is a great idea as they can help explain your options and provide further guidance.