Passive investing vs. active investing is a long-hauled debate held in the wealth management sector. Some clients and investors prefer the former since it requires less effort and generates lower fees (plus it’s tax-efficient), while others opt for the latter due to its potential for higher returns and flexibility. When should you choose the former and when the latter? How to approach both strategies? Find out the answers in this article!
Choosing Between an Active vs. a Passive Investment Strategy
First, let’s discuss passive and active investment strategies in general: how much income do they generate, what are the risks, and when to choose them? Here’s a detailed overview:
Active Investment Strategy
What is it? An active wealth management strategy is focused on real-time adjustments to the investments. It requires more knowledge about the market and the aid of a portfolio manager, who will:
- monitor the assets,
- locate promising assets to invest in,
- sell assets that build up risks,
- monitor the market and price changes to make adjustments to the portfolio.
What are the advantages? In active investing, you may expect:
- More flexibility—as an asset manager, you don’t have to follow a certain index but rather look for opportunities;
- Hedging—you can also utilize hedging as your risk management strategy;
- Risk management—since you monitor the market, you can get rid of investments if they start posing too much of a risk;
- Tax management—this also enables you to tailor your task management strategy for lower costs.
What are the disadvantages? Active investing may have certain downfalls, namely:
- Time and expenses—as a wealth manager, you will need to spend more time managing the portfolio in an active strategy; as a private investor, your wealth management fees will be much higher; it is estimated that active investing costs about 10 times more than passive investing;
- Active risk—while you can manage risks actively, you are also susceptible to misplaced investments, so the risk is generally higher;
Who is it for? Active investing is best if you or your client prefer higher returns over the initial investment cost. It also works best in emerging markets and small-company stocks, so if you specialize in these fields.
Passive Investment Strategy
What is it? In a passive investment strategy, you opt for the long haul. You don’t make frequent changes to the portfolio and opt for investments that match your target. Generally, you don’t try to outperform the market but rather match it in the long run.
Passive investment involves holding assets much longer. Usually, it’s focused on index funds that follow major indexes. It’s also a bit more popular vs. active investing.
What are the advantages? Passive investing comes with the following perks:
- Low fees and time effort—little oversight is needed, so if you’re a portfolio manager, it takes much less of your time; if you’re a private investor, you won’t pay that much in wealth management fees;
- Transparency—in this case, the investor always knows what assets are in their index fund;
- Tax-efficiency—since you don’t sell your investments, the capital gain tax is relatively low every year.
What are the disadvantages? In passive investing, you might struggle with:
- Limited flexibility—as an asset manager, you won’t have the opportunity to search and invest in promising assets;
- Smaller returns—passive investing yields lower returns vs. active investing;
- Market-reliance—the investments are closely tied to the market, so if the index follows a downward price trend, so do the assets held by you.
Who is it for? Passive investing is a safer, slower way to multiply one’s wealth. Therefore, they are a good choice if the goal isn’t to generate as much profit as possible but rather to maintain and continuously grow the investor’s wealth.
Passive vs. Active Investing in Practice
The theory behind, now let’s focus on the practical side. Should you opt for passive or active investing? Why not both?!
Blending active and passive investments is an optimal way to both maintain one’s wealth and look for higher returns. A chunk of one’s investment is secured in a steadily growing index, while another chunk is used to look for higher profit margins. The balance depends on the investor’s risk tolerance—that’s why you need to understand the expectations of your clients!
How to Improve Both Passive and Active Investing Strategies?
The best way to enhance your investing strategies is to adopt new technologies. A good wealth management platform will enable you to:
- consolidate your portfolios, including both passive and active assets,
- calculate ROIs quickly with multiple methods, depending on your goals,
- streamline client information management to build your strategies based on their risk tolerance and preferences,
- create customized reports in multiple languages based on your clients' preferences and needs.
Additionally, no matter which strategy you adopt, remember about diversified asset allocation. This will reduce the risks associated with either of the strategies.
Conclusion
Passive investing vs. active investing: which one is better? Ideally, you should combine both strategies in a proportion based on your risk tolerance and financial goals. Each of them has its pros and cons, so you should pick them accordingly: passive investing strategies for those who want a safer but slower way of increasing their net worth and active investing strategies for those who want to multiply their wealth quickly.
You might also read: Private Equity vs. Public Equity: Key Differences & Advantages
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