Passive v Active investing
Updated: Apr 24
If you've ever considered investing, you are likely to have come across these terms. But what do they mean?
Well, investors have two main strategies that can be used to generate investment returns. Active management, or passive management. This refers to which individual investments your money is invested in, and how those investments are managed. It doesn’t relate to the level of risk, or what types of investments, known as asset classes, that you invest in – for example, shares, bonds, or property. You can have an active or passive management strategy to suit every appetite for risk, and for every type of investment (asset class). Active investment management means the money you invest is managed by a fund or portfolio manager or lots of managers, known as stock pickers. These stock pickers will buy and sell particular stocks and shares in specific companies within a sector they think will grow or provide a good return. They try to ‘beat the market’. Sounds great, who doesn't want to do better than the market?! However, just because they aim to beat the market doesn't mean they will. Investments can go down as well as up, and there are no guarantees. Active management also costs - those stock pickers, and the people researching and analysing different markets and sectors, all need paying. A typical charge for active management might be 1% of your investment pot each year, every year, whether you gain or lose. Active management will also usually mean more trades; that is, more buying and selling of specific investments and stocks, as the fund or portfolio managers seek to beat the market.
Proponents of active management say it generates higher returns and better performance when markets are down, like at the moment. Critics say active management doesn't add enough value to justify its costs. Passive investment management means no stock pickers. Instead of trying to beat the market, this strategy tries to ‘buy the market’. This doesn't mean there is no strategy, or investing will be random. A passive strategy will still invest in sectors it thinks will generate good returns, for example a passive strategy may invest specifically in tech companies or large UK firms. But instead of picking specific companies within these sectors to invest in, a passive approach spreads the investment between the whole sector, either by buying shares across the sector or by tracking an index. This is why passive investment funds are sometimes known as index or tracker funds. No stock pickers, and less need for research and analysis, means passive investments have lower charges. A typical cost might be 0.3% each year. Proponents of passive investment argue that the returns from active are usually no better, and sometimes worse, than passive. Combined with the higher costs, this can result in less in your pockets. Alongside this, proponents of passive investing say that active investment means putting your faith in specific fund managers or stock pickers, which can result in risk or strategy drift, meaning your money is no longer invested in a way that suits your needs and circumstances. There are pros and cons to both strategies, and different strategies will suit different people. In reality, most investment portfolios will incorporate both active and passive investments, blending both to keep costs competitive while also trying to gain an advantage on market trends. This post is a brief explanation of passive and active investment management, and does not constitute financial advice, which is always specific to individual needs and aims. You should always seek professional advice before taking any major financial decisions.
This blog post is not financial advice and is not specific to any individual. This article is intended as generic guidance and comment only, and does not constitute any form of financial or investment advice or recommendation, which is always specific to individual needs. You should not take any actions on the basis of this article, and should take appropriate professional advice instead.
This post was published in April 2020. Legislation and policy may change over time.
All blog posts are written by Dylan Roberts in a personal capacity and do not necessarily reflect the views of Lighthouse Financial Advice Ltd, Lighthouse Group, Quilter Financial Planning, or Quilter plc.