Active vs Passive Investing: Which is Suitable for You?
When you start investing, one of the fundamental decisions you need to make is whether to choose active vs passive investing.
This decision can affect your portfolio growth, the time and money you spend towards your investments, and achievement of all your time-bound financial goals.
Let me clear up this at the outset. It was never active vs passive investing. Being a SEBI Registered Investment Adviser in Kolkata, I give credence to the fact that both active and passive style of investing co-exist.
In the ever-evolving world of financial markets, two distinct approaches—active and passive investing—have gained prominence. While these methods may seem at odds, their coexistence is vital for a well-rounded investment portfolio.
Both strategies have their own benefits and risks. In India, where investors have access to a wide variety of products, it is important to understand the different investing styles. To conclude w.r.t active vs passive investing, one needs to analyse both styles separately.
As a Financial Consultant in Kolkata, my intention is to guide clients in making simple and smart investment decisions. This article is intending to explain active vs passive investing in an easy-to-understand way.
What is Active Investing in Mutual Funds?
Active investing means when a Mutual Fund Manager tries to beat the financial markets by selecting specific stocks.
This means constantly watching the market, doing research, and making changes to the investment portfolio to get better results than the average market returns.
Objective of Active Investing
- Potential for higher returns if the Fund Manager makes good decisions
- Flexibility to buy or sell instruments based on prevailing market conditions
- Ability to avoid poor-performing sectors or companies
Challenges of Active Investing
- Higher charges (such as fund management fees) which obviously gets justified when the scheme outperforms the markets
- Greater risk of losses due to wrong decisions
- Requires time, attention, and investment knowledge
What is Passive Investing?
Passive investing is a strategy where Schemes aim to match the market performance rather than beat it.
In this method, investments are made to follow a market index such as the Nifty 50, Nifty 100, or Sensex, etc. These Schemes simply intend to copy the underlying index and hold the same stocks in the same proportion.
Objectives of Passive Investing
- Low cost due to fewer transactions and lower management fees
- Simple and easy to understand for beginners
- Minimal effort
Challenges of Passive Investing
- You only get average market returns
- Cannot avoid the bad-performing sectors in the index
- Less flexibility during market ups and downs
It was never Active vs Passive in investing
Which Investment Style is Suitable for You? How do you assess Active vs Passive investing?
Assessing active vs passive investing depends on your personal goals, risk profile, investment time horizon and the time you can give to managing your investments.
- Complementary Strengths
Both active and passive investing have unique strengths. Active investing excels in market inefficiencies, sectors with potential growth, or volatile times when market timing can add value. On the other hand, passive investing ensures stability and reduces costs, serving as a reliable base for long-term goals. - Risk Diversification
Combining active and passive strategies helps balance risk. While active investments may involve higher fees and risks, they also offer the potential for higher returns. Passive investments provide a steady, low-risk foundation to counterbalance this. - Market Efficiency and Discovery
The coexistence of these approaches benefits the broader market ecosystem. Active investors analyze undervalued stocks and drive price discovery, while passive investors bring liquidity and stability to the markets. - Cost and Accessibility
Passive strategies, such as index funds or ETFs, democratize investing by offering affordable options for retail investors. Active funds, while costlier, provide opportunities for tailored investment solutions, adding value for those with specific financial goals.
The debate between active and passive investing need not result in choosing one over the other. Instead, these strategies can coexist harmoniously, complementing each other to create a resilient and dynamic portfolio.
I strongly believe that as markets evolve, having both approaches allows you to navigate uncertainty and seize opportunities effectively. As a Fee Only Financial Planner in Kolkata, I would give prominence to both styles to tackle market turbulence.
Common Myths About Active vs Passive Investing
Myth 1: Passive investing gives low returns
Fact: Many passive funds have performed better than active funds, especially after removing high fees.
Myth 2: Active investing always gives higher returns
Fact: Even expert fund managers sometimes fail to beat the market.
Myth 3: You must choose only one style
Fact: You can mix both. Many smart investors use a combination of active and passive strategies.
Many investors use a combination of both methods to enjoy the benefits of each. The key is to stay focused on your goals and invest regularly.
To harness the strengths of both styles, as your Certified Financial Planner in Kolkata, I would emphasize on considering the following fundamentals:
- Allocate a portion of your portfolio to passive funds for cost-effective, stable growth.
- Leverage active funds in sectors or market segments where skilled fund managers can generate alpha.
- Regularly review and rebalance your portfolio to adapt to changing market conditions.
As your Financial Advisor in Kolkata, I aim to empower my clients with strategies that align with their financial aspirations, while ensuring stability and growth. By embracing the coexistence of active and passive investing, we can build a robust foundation for long-term wealth creation.
