Thinking about investing but not sure of which approach you should take? Or maybe you didn’t know yet there were different investment styles…

Let’s talk about the 2 different investing styles – passive investing.

Each investing style has its own pros and cons so lets explore what are they so you can determine which approach is right for you.

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What is the difference between active vs passive investing?

Active Investing

Active investing involves making investment decisions based on your own research (or via an investment manager) and actively buying and selling securities, attempting to outperform the market.

Active investors rely on financial research, analysis, and market timing to find undervalued shares and take advantage of short-term price movements. They aim to beat the market and generate higher returns through active decision-making.

This approach typically involves higher levels of involvement, effort, and typically higher costs (e.g. trading fees, research costs, professional fees)

Passive investing

Passive investing takes a more hands-off approach by creating a portfolio of shares that mirrors a market index, like the All Ordinaries orASX200, which means that it doesn’t actively select individual shares or time the market.  

Passive investors aim to replicate the performance of the index it is replicating, rather than to try and beat it’s performance.  This approach has a lower cost.

Passive investing is generally achieved through investing in index funds or ETFs (exchange traded funds).

ADVANTAGES OF PASSIVE INVESTING

·       Broad market which means higher diversification.

·       Lower costs as fewer transactions and management fees.

·       Simplicity and ease of implementation.

·       Less time commitment as needs less research and monitoring.

·       Long-term buy-and-hold investing.

·       Less tax implications due to lower portfolio turnover (buying & selling).

·       Receive the average overall market returns overtime.

ADVANTAGES OF ACTIVE INVESTING

·       Potential for higher returns by outperforming the market.

·       Greater control and decision-making of investments.

·       Take advantage of short-term price movements and market inefficiencies.

·       Ability to adjust investments based on market conditions or movements.

·       Potential for active tax management strategies to optimise returns.

·       Opportunity to invest in emerging or specialised sectors.

DISADVANTAGES OF ACTIVE INVESTING

·       Possibility of market timing mistakes leading to losses.

·       Higher costs: trading, research, and analysis, so outperformance can be eroded.

·       Higher time commitment and expertise to research and regularly monitor investments.

·       Increased risk of underperforming the market or making poor investment decisions.

·       Susceptible to emotional biases and behavioural pitfalls.

·       Difficulty in consistently outperforming the market over the long term.

·       Potential for higher tax liabilities due to frequent trading.

DISADVANTAGES OF PASSIVE INVESTING

·       Limitations to outperforming the market or take advantage of short-term opportunities.

·       Unable to deviate from the performance of the underlying index or benchmark.

·       Limited ability to invest in specific companies or sectors of interest.

·       Can be more vulnerable to market downturns as don’t have active risk management strategies.

WHICH STYLE PERFORMS BETTER?

The performance of active and passive funds will vary, so it’s challenging to make an accurate statement about which type performs better. The performance of active funds depends on the skill and expertise of the fund managers in making successful investment decisions.

Research studies have shown that over longer time periods, ahigh percentage of actively managed funds may not outperform their benchmark indices after accounting for fees and expenses. This is due to factors such as higher costs, the difficulty of consistently selecting outperforming companies, the challenge of overcoming market inefficiencies.

There are also times in a share market cycles when active funds outperform passive funds, however this tends to be a short time frame consistency.

Factors to consider when choosing an investment approach

1.     Confidence and knowledge: if you don’t have extensive investing knowledge, a passive approach may be a better strategy if you are just starting out investing.  Saying that, Active investing may provide an opportunity to enhance your knowledge, grow confidence, and actively participate in investment decision-making.

2.     Time commitment: Passive investing can be a more time-efficient option for time poor investors since it requires less ongoing monitoring and decision-making.

3.     Your risk tolerance: Passive is generally considered less risky than active investing since it involves diversification across a broad market index. While active investing can be riskier, as it involves making individual share or asset allocation decisions that may not always result in positive returns.

There’s no one-size-fits-all approach to investing.

Personal circumstances, goals, risk tolerance, time and preferences should guide your investment decisions.

Seeking advice from financial professionals, exploring educational resources, and increasing your understanding of investing and risk/ return can help make informed choices aligned with your individual needs and investment goals.

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