Active or Passive Investing which one is best?

What is Passive Investing?

What is Active Investing?

What is Hybrid Investing?

How can Howard Wright help me and my Investment Portfolio?

When investing your money, choosing an investment strategy can be as important as the risk level that you take. There are thousands of different investment funds available to you as an investor which can usually be classified into one of three investment strategies; Passive, Active or hybrid (a combination of Active and Passive). This is a debate in the investment world that has raged for many years and will likely continue for many more. This article is going to look at what passive and active investing is, the advantages and disadvantages of each and help you to understand which approach could be best for you and your investment portfolio.

What is Passive Investing?

Passive investing, also known as index investing or index tracking, involves investing in a portfolio of stocks that mirrors a market index, such as the FTSE 100 or the American S&P 500. By taking this approach you are not trying to beat the market but instead, you are trying to mirror the market. When using this approach you would often expect to see a buy and hold strategy implemented as you are not trying to take advantage of what an active investor may see as pricing anomalies within the market as you believe that by the time the information is available to an investor it is already in the price.

There are two types of passive fund, a physical and a synthetic. The physical fund will purchase the shares of the companies within the index it is tracking in order to simply replicate it. If there are a large number of shares in a particular index the fund provider may use a technique called optimisation to obtain the desired index exposure without buying all the constituent companies, but instead matching the risk characteristics such as sector weights, country weights (in the case of regional indices) and dividend yield.

The synthetic version of a passive fund aims to track a market or index without actually owning any of its securities by using derivative agreements. This approach may be preferred by investors wanting exposure to less liquid or harder to access markets such as commodities where they do not want to take physical delivery of those commodities.

The main positive of a passive investment is that it is usually a very low cost way to obtain a broad market exposure. As you are not paying for fund managers and analysts to make specific stock selections, the providers of the passive funds are usually able to keep costs low in comparison to actively managed funds.

One of the main downsides to passive funds is that you are usually limited in the selection of your investments. As you will be simply tracking a market you may find that you are overexposed to a small number of stocks or sectors that have a large impact on performance. You can diversify by holding numerous passive funds which track different markets but there will be areas or sectors where there are no trackers available.

Another advantage or disadvantage, depending upon how you look at it for a passive investment, is that you are unlikely to underperform or outperform a market both in a falling and rising environment as there is no manager actively trying to do so.

What is Active Investing?

Active investing, on the other hand, involves trying to beat the market by picking individual stocks or using actively managed funds where fund managers and analysts are trying to outperform a market. Unlike passive investing which theorises that all information is already taken into account in the price of an investment, an active manager believes that investors are irrational and emotions can create inefficiencies in the prices of stocks which can be exploited.

As you can imagine, active investing is more time consuming and requires greater expertise as you are undertaking research to find what you feel are undervalued companies and avoid what you believe to be overvalued companies. Because of this, you will often find that active funds are more expensive than passive funds as there are managers and analysts to pay for.

The main benefit of active investing is the potential for higher returns or limited downside risk relative to passive investing, as you can be more specific in your investment selection. Unsurprisingly, this is also one of the biggest downsides. With every active decision made, that decision could be correct or incorrect. If the fund manager gets these decisions right, you could see the fund performing much better than an index tracker. If the manager gets these decisions wrong, the downside loss could be bigger and the upside growth could be smaller compared to simply tracking a market.

Another positive is access to Investment into smaller or under researched areas is often more accessible through actively managed funds as there will be areas that passive funds do not track. Managers will also have the ability to invest more freely as they can diverge from an index allowing client’s investment requirements (such as ethical preferences) be accommodated for.

Overall, both passive and active investing have their own benefits and drawbacks, and the choice between the two will depend on an individual’s investment goals, risk tolerance, and available time and resources. A combination of both strategies (hybrid) may be used to achieve a balance of returns and risk.

What is Hybrid Investing?

Many people believe that there is no right or wrong answer to the investment approach you should be utilising as both active and passive investing have their positives and negatives. When creating an investment portfolio you may feel that neither approach in isolation is right for you and instead wish to blend the two approaches together in an attempt to achieve the best of both worlds. This is becoming an increasingly popular approach where, for example, you may wish to use passive investments for historically more stable or highly researched markets or sectors, whilst using actively managed funds in historically more volatile or under research sectors.

How can Howard Wright help me and my investment portfolio?

At Howard Wright, we offer different investment strategies for our clients and when investing your money we will discuss with you the pros and cons of each investment type and help you to choose the approach that is best to achieve your objectives.

Free Financial Review

If you would like to discuss your Investment options and what is best for you and your investment portfolio with Ashley Smith one of our Chartered Financial Planners at Howard Wright, you can call him on 0345 688 4939 or you can fill in our enquiry form below, it only takes 20 seconds to complete. We look forward to hearing from you and seeing how Ashley can help.

Disclaimer

This article contains information from sources believed to be reliable but no guarantee, warranty, or representation, express or implied, is given as to its accuracy or completeness. Howard Wright Ltd does not undertake any obligation to update or revise any future statements. Past performance is not a reliable indicator of future results. Investments can go down as well as up and actual results could differ materially from those anticipated. This article is for information purposes only and has no regard to the specific investment objectives, financial situation or particular needs of any person as such, the information contained in this article is not intended to constitute, and should not be construed as, investment or financial advice. Appropriate personalised advice should be taken before entering into any transactions. No responsibility can be accepted for any loss arising from action taken or refrained from based on this publication. Howard Wright Ltd is Authorised and regulated by the Financial Conduct Authority.

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