Active vs Passive Investing: What’s the Difference?

Active investing, as its name implies, takes a hands-on approach and requires that someone act in the role of a portfolio manager. The goal of active money management is to beat the stock market’s average returns and take full advantage of short-term price fluctuations. It involves a much deeper analysis and the expertise to know when to pivot into or out of a particular stock, bond, or any asset.

  • One of the significant advantages of passive investment management is lower fees compared to active investment management.
  • The rise of passive strategies is also evident in the mutual fund industry, where passive index strategies have witnessed substantial growth.
  • Active investors frequently buy and sell stocks, bonds, and other securities to try to outperform the market.
  • The performance of an actively managed mutual fund will vary based on the fund manager’s investment decisions.
  • Accordingly, there can be no assurance that estimated returns or projections will be realized or that actual returns or performance results will not materially differ from those estimated herein.
  • Some of these Third Party Funds are offered through Titan Global Technologies LLC.

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this post may contain references to products from our partners. Thus, downturns in the economy and/or fluctuations are viewed as temporary and a necessary aspect of the markets (or a potential opportunity to lower the purchase price – i.e. “dollar cost averaging”).

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If your top priority as an investor is to reduce your fees and trading costs, period, an all-passive portfolio might make sense for you. In our experience, investors tend to care more about factors like risk, return and liquidity than they do fees, so we believe that a mixed approach may be beneficial for all investors—conservative and aggressive alike. Some might have lower fees and a better performance track record than their active peers. Remember that great performance over a year or two is no guarantee that the fund will continue to outperform.

Active vs. passive investing

Choosing an investment strategy depends on the investor’s goals as well as their comfort and risk level in the market. Here’s a look at the difference between active and passive investing, and why investors would choose either strategy. Active investors pay more fees for research, trading, and management, which eat into returns over time (we discussed this in the pros and cons section above).

What is the Definition of Active Investing?

Hedge funds and private equity managers are one example, charging enormous fees (sometimes 10%, 15%, 20% of returns) for their investing acumen. Active vs. passive investing generally refers to the two main approaches to structuring mutual fund and exchange-traded fund (ETF) portfolios. Active investing is a strategy where human portfolio managers pick investments they believe will outperform the market — whereas passive investing relies on a formula to mirror the performance of certain market sectors. Active investment strategies can also include trading in options, futures, or other derivatives to enhance returns or manage investing risks. The performance of an actively managed mutual fund will vary based on the fund manager’s investment decisions.

Active vs. passive investing

There, they are able to buy or sell publicly traded investments as desired, based on current market conditions. Active investors generally manage their portfolios, while passive investors might build their portfolios through managed investment strategies. Active management requires a deep understanding of the markets and how assets move based on what’s happening in the economy, the rest of the market, politics, or other factors.

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They continuously monitor and adjust the portfolio holdings based on their analysis and market conditions. The goal of the actively managed portfolio strategy is to outperform the overall market or a specific benchmark index by selecting securities that are expected to generate superior returns. Passive investors typically buy and hold these funds for the long term, allowing their investments to align with the overall market returns. Index funds are popular passive investment options as they offer broad market exposure, low fees, and the convenience of diversification. Passive investors believe in the efficiency of markets and the long-term benefits of staying invested in the market as a whole.

Active vs. passive investing

We work with those we believe offer a disciplined investment process that will help them generate long-term returns for you. Active investing involves fund managers making active decisions over what to invest in. The main advantage of Active Investment Management is the potential for higher returns than market benchmarks, as skilled managers can identify undervalued assets and adjust their portfolios accordingly. Managers need to conduct detailed market analysis, research, and portfolio management to identify undervalued assets and market trends that can result in higher returns than the market benchmark. The portfolio managers use their expertise and market analysis to select individual securities that they believe will outperform the market.

Active vs. Passive Revisited: Six Observations

Let’s break it all down in a chart comparing the two approaches for an investor looking to buy a stock mutual fund that’s either active or passive. Despite the fact that they put a lot of effort into it, the vast majority of of active fund managers underperform the market benchmark they’re trying to beat. It is reasonable for them to expect active managers to define and measure their ex-ante alpha, especially if they are simply extrapolating it from the past. But investors have to evaluate that ex-ante expectation or have a well-developed forward view of where that alpha will come from.

Its articles, interactive tools and other content are provided to you for free, as self-help tools and for informational purposes only. NerdWallet does not and cannot guarantee the accuracy or applicability of any information in regard to your individual circumstances. Examples are hypothetical, and we encourage you to seek personalized advice from qualified professionals regarding specific investment issues. Our estimates are based on past market performance, and past performance is not a guarantee of future performance.