Active vs Passive Investing Header

Active vs Passive Investing

Are you trying to understand the differences between active and passive investing? Do you want to know which strategy is best for you? In this post, I will do a comparison of active vs passive investing. After reading this post, you will better understand why you should choose a passive investing strategy.

First of all, let’s clarify what active and passive investing are:

  • Active Investing:

    The investor takes an active role in the investment, buying and selling actions. More info here.

  • Passive Investing:

    The investor takes a passive role, thus its name, by reducing the activity to a minimum, avoiding both the fees and the lower performance that come from frequent trading. More info here.

Although the word passive can have a negative connotation, it is not the case for investing. So, what are the advantages of passive investing?

Time

By definition, this is a very obvious advantage, but one that people do not usually think about a lot.

Because you are aiming to reduce your activity to a minimum, you can spend your time engaged in other activities of your choosing.

Instead of constantly monitoring your investments and dissecting companies’ financial statements, you can spend your time travelling or building relationships.

Peace of mind

A very important advantage.

Due to the nature of our minds, active investing is an additional stress to our life. You will second guess your decisions and hit your head on the wall when one of your investments declines.

On the other hand, with passive investing, you don’t need to worry about choosing because you will be owning investment options that are greatly diversified, also reducing the risk in your portfolio.

Performance

This is probably the most important advantage for most people out there. Wall Street has been doing a great job hiding it, but the mounting evidence and the Internet are slowly helping people become aware of it.

If you want to invest long term, passive investing funds outpace actively managed funds almost all the time. As John Bogle explains in his masterpiece Common Sense on Mutual Funds, only one out of five active managed funds outpace the market index. This means you have four out of five options to choose an actively managed fund that will perform worse than the market index.

On the other hand, if you are thinking about picking the stocks yourself, you need to remember the following:

  1. The stock market is a zero-sum game. That means that if you outpace the market, somebody else must lag behind by the same amount.
  2. The financial institutions you will be buying from or selling to spend millions of dollars researching opportunities. They have hundreds of people employed whose job is to look for those opportunities. They also have access to information you could never dream of accessing.
  3. Even the best investor of our time would choose passive investing over active investing.

I hope you have found this post useful. In next posts I will explain in more detail what passive investing is, tips you can follow to increase your return on the long term, passive investment focused on achieving your retirement goals and much more.