What are the benefits of passive v active investing
I thought I might use the opportunity today to kick it up a notch and cover a slightly more advanced topic than usual. I am regularly asked by people, ‘what is the best investment’, or ‘which investment will make me the most amount of money’. If there was a simple answer to this there really would be no need for financial professionals as everybody would simply select ‘the best investment’.
The best investment is one that fits your goals, investment timeline and risk tolerance. What is the perfect investment for one person may be the worst investment possible for another. It should also be noted that nobody truly knows how an investment is going to perform; anyone who tells you otherwise should be swiftly avoided. All we can do is look at historical averages and make calculated decisions.
We have previously spoken about managed funds and specifically fund managers whose job it is to invest money on your behalf. The possibilities of how a fund manager may invest your money is unlimited with a fund for every investment style in existence, plus some you didn’t even know about. Today we are going to talk about the difference between passive v active investing.
Some fund managers may describe themselves as ‘passive investment managers’. A passive investment manager is of the view that the market (whether that be the stock market, property market etc.) is going to do what it is going to do and the process of trying to ‘beat the market’ by making calculated trades will hurt an investor in the long run. The passive investment manager looks at the historical norms expected from investments and seeks to obtain a similar return. Usually, a passive investment manager will pick a benchmark such as the ASX200 (the top 200 Australian shares) and seek to match its returns. The benefits to such an investment strategy are that fees are usually lower than their active managing counterparts which is good for the overall balance of the investment.
Fund managers who describe themselves as ‘active investment managers’ take a different view to a passive investment manager. They consider that the market is not as efficient as a passive investment manager might think and by executing certain trades at certain times, they may in fact, beat the market. Usually, an active investment manager will pick a benchmark such as the example given above and will deviate it from it slightly at strategic times with the purpose of beating that benchmark. Of course, with more active management, the fees and costs associated will generally be greater.
This description is extremely generalised and changes from fund to fund, like I said, there are unlimited possibilities as to how your money may be invested. Whether you wish to place your money in a fund that has active or passive investment will depend on a number of factors including your tolerance for risk. Whilst active investment managers may try to beat the market, when they are unsuccessful they may perform worse than the market. Your financial adviser should be able to determine your level of risk tolerance and discuss with you the options and why they consider them appropriate for you.
If you have any questions, as always, please feel free to post them below.
This post is from Ben Brett. Check out our details in the About Us page.