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One of the foremost issues encountered while constructing investment portfolios is the type of strategy to be used while choosing investments and whether this should be active or passive. Whereas one aims to beat its underlying benchmarks and potentially offer greater returns, the other focuses on matching the broad market performance. Each with their own merits and shortcomings, active and passive investing strategies have often fostered a heated debate in the financial world.
Here we break down the two approaches and how they differ in their objectives and tactics, while we analyse why both strategies can have a role in your portfolio.
A hands-on approach that aims to beat the market or outperform a certain standard benchmark, active investing requires a portfolio manager who can take full advantage of short-term price fluctuations and who can conduct an independent assessment of each investment’s worth so that ultimately, they can select the most attractive option. Securities are bought and sold often based on daily fundamental company research, historical earnings and an analysis of the underlying industry. Whereas some portfolio managers specialise in picking individual stocks they believe will outperform the market, others invest in sectors or industries they think will do well.
If we assume that your goal is to achieve better returns than the S&P 500, then actively investing in a hedge fund that involves high levels of leverage and is focused on absolute returns as opposed to following the benchmark performance can help you achieve your objectives.
With active investing professional investment managers pick the right investments on behalf of investors. When things go well, this approach can deliver good returns and this together with other advantages make active investing appealing. However, just like any other investing approach, there are drawbacks, such as the fact that there is no guarantee the desired performance will be delivered. Below are some more advantages and disadvantages.
A more balanced investment approach that aims to match the broad market performance, passive investing focuses on the long-term and on a buy-and-hold approach, while it resists the temptation to react or anticipate the stock market’s next move. At the same time, passive investors limit the amount of buying and selling within their portfolio and in turn, the costs associated with frequent trading or research analysis. What’s more, it is a strategy typically preferred by those with a lower risk tolerance.
A simple example of passive investing is buying an index fund that follows one of the major indices, such as the S&P 500 or the Dow Jones Industrial Average (DIJA). Your fund manager switches holdings based on the changing composition of the index being tracked by the fund. So if, for instance, the S&P 500 changes its constituents, then the index fund that follows it will automatically switch its holdings by selling the stock that is leaving the index and buying the stock that is about to become part of the index.
Passive investing’s set-and-forget approach, together with its relaxed nature can be an advantage in itself for some investors, however, there are other benefits worth considering. On the other hand, it does have its limitations as outlined below.
Below is a snapshot of some of the key differences between active and passive investing:
Active investing is followed across a number of instruments. Here are just some examples.
Hedge funds: with these types of funds, a portfolio manager actively tries to outplay the markets.
Mutual funds: the objective here is to outperform index funds.
Day traders: these actively buy and sell on the market on their clients’ behalf.
Wealth managers: these are hired by individuals to manage their portfolio with capital invested by the client.
On the other hand, passive investing can take several forms. These may include:
Index funds: these track several companies across a given stock market index and may also include some mutual funds.
ETFs: most ETFs are considered passively managed funds. One example of an ETF is the Vanguard S&P 500 ETF (VOO).
Which of these strategies offer better returns? For most people, there is a time and a place for both active and passive investing over their lifetime, often depending on the financial milestones they would like to achieve. As mentioned earlier on, active investing has the potential to earn higher returns compared to the market, however, doing so comes at a cost, taxes and time dedicated for research, while it may involve higher risk. On the other hand, passive investing has the potential to consistently earn the equity risk premium with a low-cost exposure and less research, however, it ignores the market fluctuations and as a result, the possibility of earning higher returns and outperforming the benchmark.
Typically, retail investors, in other words, non-professional / non-discretionary investors, prefer passive investing due to the fact that they would rather leave the day-to- day and active management of their investments in the hands of experienced and qualified fund managers. However, investors always have a choice on how to best diversify their investment portfolio.
In essence, it does not have to be an either-or choice. Investors can make the most of their money through a mix of both active and passive investing approaches across different asset classes and market conditions. As always, consider your financial situation, your life stage, as well as your ability to tolerate risk before taking any decision.
Looking for an advisor who can help you build a diversified portfolio that includes both investment strategies? Qualified and boasting a wealth of experience, Calamatta Cuschieri’s advisors can address clients’ unique needs and draft a customised financial strategy, whilst acting in the best interest of clients. At the same time, they have access to a full range of investment products which means that they can directly invest in the markets. Here are some of the benefits on enlisting an advisor’s help:
By actively taking into consideration the complexities of your finances, your personal circumstances, as well as your short and long-term objectives, our advisors can provide the necessary advice and work with you to establish investment decisions with your best interest in mind.
With our financial advisors you are safe in the knowledge that an experienced professional is taking care of a wide range of challenges on your behalf, keeps close tabs on the markets, while conduct thorough research to identify the best investment opportunities.
Thanks to our simple and easy to understand fee structure, not only you’ll know exactly what you are paying for, but it is also highly competitive and transparent. We do not charge annual management fees, custody fees or any other hidden, recurring fees.
Have a look at the right questions to ask before making any investment.
The information provided on this website is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Similarly, any views or opinions expressed on this website are not intended and should not be construed as being investment, tax or legal advice or recommendations. Investment advice should always be based on the particular circumstances of the person to whom it is directed, which circumstances have not been taken into consideration by the persons expressing the views or opinions appearing on this website. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views, or opinions appearing on this website. You should always take professional investment advice in connection with, or independently research and verify, any information that you find or views or opinions which you read on our website and wish to rely upon, whether for the purpose of making an investment decision or otherwise. CC does not accept liability for losses suffered by persons as a result of information, views, or opinions appearing on this website.
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