Active vs. Passive Investing

For Millennials who have earned the right to invest, learn the pros and cons of active and passive investing.We talk a lot on the blog about earning the right to invest because some Millennials still need to work on setting goals, mastering cash flow and establishing a cash reserve. However, many Millennials are ready to invest. If you are one of those Millennials, high five!  If you still need to work on the basics, check out these prior blog posts first: Back to Basics Part 1: Mastering Cash Flow and Back to Basics Part 2: Establishing a Cash Reserve.

But for those of you ready to invest, one of the first topics you may read about is active versus passive investing. They are hot buzzwords in the news as passive investing has become more popular in recent years.  There has been a lot of money flowing out of active funds and into passive ones. I think one reason for this trend is the rise of technology and Robo platforms that often utilize passive funds.  Because Millennials are fee conscious, we look for options that can provide us with lower fees. But do you understand the trade-offs?  Let’s look closer at the difference between active and passive investing.   

Active Investing
With active investing, you are investing in funds that have a portfolio manager who is picking funds to try and beat a certain benchmark. The managers look at lots of factors including the economy, politics, and the individual companies when deciding which stocks to buy and sell and when to buy or sell them.

Pros

  • Can have the opportunity to outperform an index or benchmark
  • May limit the downside or exposure to market dips
  • Expert analysis

Cons

  • Potential to under-perform the index
  • Potentially higher fees and operating expenses
  • Less tax efficient

Passive Investing
With passive investing, you are investing in funds that simply contain the same stocks in the same proportions as a relevant benchmark.

Pros

  • Cost efficient
  • Likely to perform close to the index or benchmark
  • Simplistic

Cons

  • Unlikely to outperform an index
  • Subject to market dips
  • Not research based

What’s right for you?

As usual with investing, there isn’t a short, easy answer.  Most investors will need to find a balance based on their expense budget for investing and what their goals are.  I tend to look towards active investing for less covered areas of the market. This means for things like emerging markets and fixed income, having an expert managing the funds may be beneficial.  For something like large U.S. markets, a passive fund may meet the need.

If you are starting investing with your 401(k) (which is where most people start), you may not have many options for funds either active or passive. Some young investors simply put their whole 401(k) into an S&P 500 fund which can be a good place to start. However your plan may have other options and you may be able to diversify with a better risk to reward profile.  Many plans have a Financial Advisor attached to them so look to see if there is a professional who can help you build a portfolio to meet your needs. No matter where you start investing, make sure to have a plan and invest towards your goals.

I hope you find these tips helpful and if you want to educate yourself more check out our book, The Millennial Money Fix, which comes out this month. You can pre-order yourself a copy today.

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Disclosures:

An actively managed investment fund is a fund in which a manager or management team makes decisions about how to invest the fund’s money. Such decisions are made in an attempt to do better than the market and involve actively choosing which investments to purchase, hold, and sell for the fund. The fund manager performs an analysis using in-depth techniques and methods that may involve numerous investment options. The goal of an actively managed fund is to perform better than the specific market index with which the fund is being compared.

Passively managed funds, such as index funds or exchange-traded funds, typically invest in the same securities that make up a particular market index in an attempt to match the performance of that index. Because there is less work involved with managing passive funds, they tend to have lower fees than actively managed funds. A passively managed fund does not have a management team making investment decisions. Instead, the fund manager creates a fund portfolio that includes most, if not all, of the associated index’s holdings with the goal of trying to achieve the same returns as the index. Instead of making numerous and frequent trades, which occurs with active management, passively managed funds typically hold onto their underlying securities for the long run. Long-term growth and portfolio diversity, which can help minimize risk, are key advantages of passively managed funds.
Asset allocation programs and diversification do not assure a profit or protect against loss in declining markets. No program can guarantee that any objective or goal will be achieved.