Active Versus Passive Investing

Active implying a ‘hands on approach’ to investing, and Passive a ‘hands off approach’ to investing.

Both passive and active investing strategies can be applied to a wide range of asset classes.

Active Versus Passive Investing

  • Equities [Shares or Stocks]  
  • Fixed Interest [Bonds]
  • Real Estate [Residential, Commercial, Industrial]
  • Commodities [Raw materials]
  • Alternative Investments

For this article, reference is only made to equities, however there will be future articles covering the other asset classes. 

Active investors, as the name suggests, take an active role in the decisions that effect their investments.  This may be by making personal decisions or relying on an active third party, such as a fund manager to make the investment decisions.  The decisions they make are about choosing investments for the portfolio and if/when these investments should be sold.  Their investment portfolio is characterised by purchasing individual stocks, frequent change with a relatively high turnover of assets. 

Alternatively, passive investors have a long-term view and generally invest in index funds or index ETF’s that are managed on behalf of the investor.  These funds and ETF’s are invested in an index such as the ASX Top 200.  In this example, the fund manager invests the pooled funds of many investors in shares of the top 200 companies listed on the Australian stock exchange.  The decision to buy and sell shares occurs only when there is a change to the makeup of the ASX top 200 companies.  A passive investment portfolio is characterised by investing for the long-term with a low turnover of assets.

The main differences between active and passive investing are:

  • Active investing is hands-on and usually relies on investment decisions made by a portfolio manager who relies on information provided by a team of analysts.
  • Passive investing is long-term with investors participating in an index fund or ETF where the fund manager duplicates a selected index.
  • Active managers sometimes deliver very high short-term returns. However, history demonstrates that the ability of an active manager to provide high returns in the medium to long term is rare.
  • Retail investors (you and me investors) have shown a strong preference for passive investing in recent years.
  • Passive investing strategies have provided long-term investors with higher historical returns than the average of returns achieved by active investing strategies.

The advantages of passive funds are the transparency, low fees, and lower capital gains tax due to low fund turnover.  The disadvantages of passive funds are the limitations imposed by not being exposed to higher risk-return strategies.  Also, where an active manager has made lucrative investment decisions a passive manager is restricted to returns that track the market index. 

The key advantage of active investing is the ability to choose stocks where there is a belief that these will outperform the market. The disadvantages of active investing are the high cost of active investment management and the investment risk associated with buying individual assets that may or may not, perform.

Many studies have shown that passive investing has provided higher long-term returns than the average returns achieved by an active investing approach.  However, it is important to recognize that among active managers there have been numerous stellar performances with outstanding short-term investment returns

The answer lies in an investment approach that uses, the best of both, blending passive and active investments, often described as a “core and satellite approach” where most of a portfolio is held in passive investments (the core) and with a smaller exposure to active investments (the satellites).

This offers the potential to gain the combined benefits of both passive and active investing. It’s a popular approach for investors seeking a balance between risk and return.

The core portion provides a steady foundation, reducing overall portfolio volatility.

The satellite portion can add extra returns if your active investments outperform the market.


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