Key Difference – Active vs Passive Investing
Investing activity may be active or passive in nature, depending mainly on the approach and attitude of the investors who undertake investing. The key difference between active and passive investing is that active investing refers to frequently buying and selling of investments in order to make swift profits whereas passive investing is concerned about creating wealth in the long term by only investing in a selected range of investments. Whether to adopt an active or passive approach to investing mainly depends on the nature of the risk appetite and the objectives of particular investors.
CONTENTS
1. Overview and Key Difference
2. What is Active Investing
3. What is Passive Investing
4. Side by Side Comparison – Active vs Passive Investing
5. Summary
What is Active Investing?
Active investing refers to a situation where investors purchase investments and constantly monitor the movements in them. The logic behind active investing is to obtain as many as possible information with constant tracking of the investments in order to exploit high-profit possibilities. Active investors often spend a significant time and are passionate regarding investing activity. They are generally risk takers who buy and sell stocks fast in order to make higher profits in the short term. Active investors typically do not hold stocks for many months or years; they are rather interested in daily price movements. They usually do not focus on long-term economic conditions. A transaction cost should be paid by investors when conducting a trade in the stock market. Since active investing involves a high volume of trading, increased transaction costs also occur.
Technical analysis and fundamental analysis are two key methods that active investors use to gain information regarding stocks.
Technical Analysis
Technical analysis involves evaluating the upward and downward movements in stock charts with the intention of predicting the future movements
Fundamental Analysis
In contrast, fundamental analysis considers a wide number of factors including the status of the economy, stock markets and industry variations in order to measure the intrinsic value of stocks. Intrinsic value is the actual value of an asset after considering all tangible and intangible elements that contribute to its value.
What is Passive Investing?
Passive investing is an investment strategy where investors attempt to make profits from investments over a long period of time. Daily movements in prices are not the concern of passive investors, and they keep buying and selling of securities to a minimum. Unlike active investing, passive investing is aimed at steady wealth creation over time. Passive investors are generally risk averse ones who do not wish to profit from short-term price movements. Since the process of buying and selling securities is infrequent, low transaction costs result in passive investing.
Passive investing is common in the equity market, where index funds track a stock market index, but it is becoming more common in other investment types, including bonds, commodities, and hedge funds. Passive investing has gained increased popularity in the recent years as an alternative to active investing. In fact, a research conducted by World Pensions Council suggested that between 15%-20% of investments in large-scale pension funds are passive investments.
What is the difference between Active and Passive Investing?
Active vs Passive Investing |
|
| Active investing refers to frequent buying and selling of investments in order to make swift profits. | Passive investing is focused on creating wealth in the long term by only investing in a selected range of investments. |
| Type of Investors | |
| Active investing is predominantly done by risk-taking investors. | Many risk-averse investors engage in passive investing. |
| Transaction Cost | |
| Active investing incurs high transaction costs. | Passive investing results in low transaction cost due to the infrequent trading. |
| Price Movement | |
| The focus in active investing is about short-term price movements. | The focus in passive investing is about long-term price movements. |
Summary – Active vs Passive Investing
The difference between active and passive investing depend on the short term or long term orientation. Investors can select which approach is suitable for them depending on how much risk they are willing to take. If an investor wants to make a quick return within a short period of time active investment is the most appropriate option. On the other hand, passive investments can be made by investors who prefer to take a laid back approach to investing or those who are not interested in tracking every price movement in the market.
References
1. “Active Investing.” Investopedia. N.p., 17 Nov. 2003. Web. 03 Apr. 2017.
2. Floyd, David. “Passive Investing.” Investopedia. N.p., 18 May 2016. Web. 03 Apr. 2017.
3. Stanley, James. “DailyFX.” DailyFX. N.p., 18 July 2012. Web. 03 Apr. 2017.
Image Courtesy:
1. “Philippine-stock-market-board” By Katrina.Tuliao – (CC BY 2.0) via Commons Wikimedia