Active vs passive investing: which strategy is best for you?

What is active investing?

Active investing is a hands-on approach where fund managers or individual investors take an active role in selecting and managing investments. 

The goal is to outperform a specific market index by carefully timing trades and picking assets with growth potential. This requires continuous analysis and decision-making backed by deep research and market expertise.

Active investment strategies typically involve professional fund managers who track market trends and adjust portfolios as needed. However, despite their efforts, success is not always guaranteed.

Popular types of investment strategies include hedge funds, sector-specific funds, and portfolios targeting undervalued or growth-oriented stocks. These approaches aim to take advantage of short-term opportunities or market inefficiencies to deliver higher returns.

What is passive investing?

Passive investing takes a different approach. It focuses on matching the performance of market indices instead of trying to beat them. Investors achieve this by replicating the composition of a market index, like the FTSE 100, through funds designed to follow the same structure.

This method is long-term in nature and requires minimal intervention. It’s why passive investment strategies are often considered ideal for those seeking steady growth with less complexity.

Index funds and exchange-traded funds (ETFs) are two of the most popular tools used in passive investing, offering diversified exposure at a lower cost.

The simplicity and cost-effectiveness of this approach have made it increasingly popular. For investors prioritising steady returns and ease of management, passive investing is a practical and reliable option.

What are the key differences between active and passive investing?

When comparing passive and active investing, these are the key differences:

Management style

The core difference between active and passive investing lies in how the portfolios are managed. With active investing, decisions are made by fund managers who rely on research, intuition, and experience to choose investments.

In contrast, passive funds aim to mirror an index, requiring no ongoing decision-making. This difference makes active strategies more labour-intensive.

Costs

When comparing passive and active investing, the cost is a significant factor. Actively managed funds come with higher fees due to the research, transactions, and expertise involved.

These can exceed 1% annually. On the other hand, passive investment strategies are significantly cheaper, often charging fees as low as 0.1%. 

Risk

The risk levels in active investment strategies can vary widely. As fund managers aim to outperform the market, there’s always the potential for greater gains—but also bigger losses.

Passive investing carries less risk because it tracks the broader market, offering more predictable returns. For risk-averse investors, passive strategies are often a safer choice.

Performance

The performance of active and passive investment strategies can differ significantly.

Active investors aim to outperform the market but often fall short, while passive strategies often deliver consistent returns that align with the market. 

What are the pros and cons of active investing?

Active investing has different advantages and disadvantages.

The pros of active investing

• Potential for higher returns: Skilled managers may identify unique opportunities that deliver significant gains.

• Customised portfolio strategies: Active investors can tailor their holdings to match specific goals or preferences.

• Flexibility: Fund managers can quickly respond to market changes, capitalising on emerging trends or avoiding downturns.

The cons of active investing

• Higher fees and costs: Active funds typically charge much more than their passive counterparts, which can erode returns over time.

• Greater risk and volatility: The same strategies that offer the chance of higher returns also come with increased exposure to market swings.

What are the pros and cons of passive investing?

There are also advantages and disadvantages to consider with passive investing. 

The pros of passive investing

• Lower fees and management costs: With minimal trading and no active decision-making, passive strategies keep costs low.

• Consistent long-term performance: Because they track indices like the FTSE 100, passive funds provide reliable returns aligned with market growth.

• Ease of access: ETFs and index funds are simple to set up and manage, making them suitable for a wide range of investors.

The cons of passive investing

• No chance of outperforming the market: Returns are limited to market averages, which may not appeal to more ambitious investors.

• Limited flexibility: Passive funds are tied to their index, which means they can’t adjust to short-term opportunities or avoid losses during downturns.

Which investing strategy is best for you?

Choosing between passive and active investing depends on your financial goals, risk tolerance, and investment experience. 

Active investing may appeal to those with a higher risk appetite, significant capital, or a desire for tailored strategies. For example, high net worth individuals might accept higher fees if it means gaining access to niche markets or innovative opportunities.

Passive investing suits beginners or those prioritising simplicity and cost-efficiency. Its low-maintenance nature and steady returns make it an attractive choice for long-term growth. 

Ultimately, understanding your risk appetite, financial goals, and time horizon will help determine which approach works best for you.

Can you combine active and passive investment strategies?

Yes, combining active and passive investment strategies can create a balanced portfolio. Many investors use passive investment tools such as index funds as a foundation while exploring active opportunities to enhance returns. 

For example, you might rely on passive funds for stability while allocating a portion of your portfolio to actively managed investments targeting high-growth sectors. This approach blends the strengths of both strategies to achieve diversification and growth.

Do I need professional advice when actively or passively investing?

Professional guidance is often invaluable when weighing up active or passive investing.

Financial advisers can help you evaluate your goals, risk tolerance, and financial situation, ensuring your investment choices align with your broader plans. 

Whether you opt for active or passive investment, expert advice can optimise your strategy and increase your chances of success.

Get expert financial advice

When deciding between active and passive investing strategies, the choice ultimately depends on your personal financial goals, risk tolerance, and investment style.

Both types of investment approaches offer unique advantages, and for many investors, a blended strategy can provide the best of both worlds. 

Whether you prioritise the cost-efficiency and reliability of passive investing or the potential for higher returns with active investing, seeking professional advice can help you navigate your options and create a plan that aligns with your long-term objectives.

Let Unbiased match you with a professional financial adviser to help you navigate passive and active investing and create a strategy tailored to your goals.