If you have been in the world of investing for some time you must have heard about the terms ‘Active Investing’ and ‘Passive Investing.’ Investment gurus around the world have been divided over 2 styles of investing active and passive and since many decades they try to decode which one is better.
Today, we will try to demystify these terms and will help you to decide which one is right for you.
Styles Of Investing
Investing is as much as science as it is an art. It requires years of practicing to master and is not easy at all. You need to first learn it and then select the stocks carefully to arrive at the most optimal portfolio that gives you the best returns. This will require you to go through a lot of trials and errors before you end up finding out how to do it in the best way.
All these require time and expertise, which you may not have. But does that mean that you can not benefit from the stock markets?
Fortunately, the answer is ‘no.’ This is where these styles of investing come to your rescue.
Active investing
In Active investing, the investor of the fund manager of a mutual fund tries to buy and sell stocks frequently to take advantage of the short-term ups and downs in the market and the prices of the individual stocks.
They try to enter the stocks which are expected to go up in the future and exit them when the price rises. Thereafter, they put the money again in another stock which is expected to go up.
The goal of active investing is to generate returns from a portfolio which is higher than the market returns. Hence, they often engage in active trading as well. They monitor the stock markets regularly to decide how the portfolio is performing in which stocks to buy, hold and sell.
Advantages of active investing:
- In this style of investing the portfolio undergoes frequent changes and the returns can be very high when this active investing is done properly.
- Since the portfolio is monitored regularly, the investor can identify stocks which are not performing and exit them quickly. In this way they can reduce losses from the portfolio.
Disadvantages of active investing:
- The expense of maintaining this portfolio is also very high because whenever you buy or sell a stock, you will have to pay a brokerage and various other taxes. This can reduce the returns you earn.
- The return from active investing quite uncertain and is heavily dependent on the skill sets of the investor of the fund manager. In many cases the fund manager can beat the index and get returns which are higher than what it has generated. But there are many other instances where the fund manager has failed to do so, and the portfolio has generated considerably lower returns or even earned losses.
Passive Investing
In passive investing the investor or fund manager creates a portfolio of stocks which is identically similar to another portfolio of stocks or an index.
For example, mutual fund house can create a passive fun which reflects a popular index like Nifty50.
Such a passive portfolio will carry all the 50 stocks that are present in Nifty50 in the same proportion as in the index. Hence, the price movement of this passive portfolio will also reflect the price movement of Nifty50.
When the price of Nifty50 will go up the value of this portfolio will also increase and vice versa. At the end of the year the returns from this portfolio in percentage terms will be very close to the returns that are generated by Nifty50.
A passive portfolio can be built with any index in mind, and not just Nifty50. The goal is to earn returns similar to the market return and not to beat the market in anyway.
As you might have noticed passive investing yes easier than active investing since it does not require constant rebalancing of the portfolio. The portfolio will only be changed when the benchmark index undergoes any change otherwise not.
Advantages of passive investing
- Since in passive investing their portfolio is created and not rebalanced very frequently it requires much less time and knowledge on the part of the investor to execute.
- This style of investing does not involve frequent buying and selling of stocks. Hence the expenses on the portfolio are low.
- Since the portfolio returns are similar to the index returns, your returns will be linked to market cycles and not the individual skill sets of any fund manager.
Disadvantages of passive investing
If you are looking for very high returns and have the risk appetite as well then passive investing may not be for you. Since this is the defensive style of investing, the returns are always going to be similar to the returns generated by the benchmark index. If you are looking for higher returns, than you might have to go for active investing.
Which one should you go for?
Whether you choose active investing will depend on your time available for goals, risk appetite and how much patience you have. You can choose Passive Investing Style if you-
- cannot devote much time to portfolio management and
- are looking for stable returns
However, if you are having the time to trade/invest actively and can take the excess risk to generate high returns from your portfolio then choose active investing.
Our ILTS strategy offers the best of both styles
At Finideas, we have created an investment strategy called Index Long Term Strategy which combines the best of both active and passive investing. In this, we invest a part of the funds of our clients in the Nifty50 Exchange Traded Fund, which is a passive fund.
The rest of the fund is used to trade actively in futures contracts with full protection with options contracts. This brings in the best of both worlds and the returns are very high. If you want to retire rich, then chat with us to know more about this strategy.
Happy Investing!
This article is for education purpose only. Kindly consult with your financial advisor before doing any kind of investment.
