Active vs. Passive Investing: It's Time to Understand the Difference Once and For All
About the author: Lamar Watson, CFP®, is a Fee-Only Financial Advisor in the Washington, D.C. area that works with clients virtually across the country. Lamar's work with his clients focuses on budgeting, employee benefits, paying down debt, buying their first home, and investing. Lamar is the Founder of Dream Financial Planning, a virtual Fiduciary Financial Planning firm specifically designed to help young professionals and minorities take control of their finances and fulfill their dreams. Feel free to schedule a complimentary consultation to learn how we use the DREAM Financial Planning Process ™ to help our clients achieve their goals.
Even with the onset of COVID-19, major online brokers saw new accounts grow as much as 170 percent in the first quarter of 2020.1 For investors, whether working with an advisor or taking a DIY approach, it’s important to understand the fundamental differences between two common investing practices - active and passive.
What Is Active Investing?
Some investors may look at active investing with a goal of “beating the market” and outperforming specific standard benchmarks. In order to do this, investors may follow investment trends and buy or sell as investments rise and fall.
Investment advisors may actively invest assets such as:
- Mutual funds
- Exchange-traded funds (ETFs)
- Portfolios of stocks, bonds, and other holdings
The general idea surrounding active investing is that if things go well with your investments, you may be able to outperform the market, even including the fees you pay to your advisor or broker. Performance, however, is never guaranteed.
Active Investing Considerations
If you’re working with an investment advisor or team of advisors, a person (or team of analysts) may be picking individual stocks or sectors of the market to invest in.
Fees vs. Performance
Having an advisor or advisory firm actively manage your portfolio can incur higher fees than those who follow a passive investment strategy. Because of this, an investor would want to beat the market by a certain percentage in order to make paying the higher fees worth it in the long-run.
What Is Passive Investing?
By practicing passive investing, you aim to maximize your returns while minimizing the amount of buying and selling that you do. With this strategy, investors may buy and hold their stocks and bonds in passive funds or passive index funds.
These funds rise and fall to match the performance of certain indexes. Because of this, passive investments are not meant to beat or outperform the market, but rather match the market’s performance.
Passive Investing Considerations
Potentially Lower Fees
Because passive funds don’t have such a hands-on human component to them, they tend to incur fewer fees than active investments.
An investor will know exactly what stocks or bonds their indexed investment contains. For some, this transparency and consistency may be comforting or reassuring to know as they work toward their long-term financial goals.
Which Is Right For Me?
Some investors may find a mix of both active and passive investments the right move for diversifying their portfolio. With the lower fees, passive investments tend to incur, it may be an appealing option for investors who don’t have the time or desire to actively manage their investments or can’t hire someone to do it for them.
How you choose to invest will likely come down to your priorities, desired personal involvement, and long-term goals. If you’re unsure what direction to take your investments, an investment advisor can help explain your options and provide further guidance.
Dream Financial Planning Process ™
Whether you're managing student loan debt, starting a family, or considering buying your first home, the DREAM Financial Planning Process™ is tailored to the unique needs of busy professionals in their 30s and 40s. This process focuses more on short-term goals while you grow and evolve in your personal and professional life. If you're looking for guidance on Financial Planning, optimizing employee benefits, budgeting, student loans, and managing your 401k or investments, we can help.
With uncertainty surrounding the economic stability of our country, it's okay to have fears and anxieties surrounding your own savings and investments. The most productive course of action from here is to reach out to Dream Financial Planning (or whoever your trusted advisor might be) and discuss your options. It's easy to have knee-jerk reactions when it feels like the bottom is falling out, but it is imperative to make decisions using research-backed data and a level head. If you'd like a Complimentary Review and risk assessment of your investment portfolio, feel free to send me an e-mail.
If you're looking to buy your first home, you'll want to read this month's Newsletter. In my February Newsletter, I discuss how student loans could affect your ability to buy a home with Megan Leonhardt of CNBC. There are also blog posts that discuss 7 Tax Deductions For The Self Employed and 4 Common Mistakes Made by First Time Homebuyers.
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