As retail investors slowly become more investment-savvy, it is common to hear the division in opinions between the two main investment strategies: active portfolio management and passive portfolio management.
As the names suggest, these two approaches differ in how the investor (or sometimes, the fund managers who invest on behalf of the investor) utilises investments held in their portfolio over time period.
Active portfolio management focuses not on making money, but on outperforming the market compared to a specific benchmark. On the other hand, passive portfolio management aims to mimic the investment holdings of a particular index. This is usually known as “indexing”. It is interesting to note that both these style of portfolio management peg their performances against the market returns, rather than simply aiming to make money.
That being said, none of them are actually one-size-fit-all solutions as there are advantages and disadvantages for different categories of investors. We will explain some of the striking differences between them.
Pros and cons of Active Vs Passive Investing
Benefits and Tradeoffs of each methodology
There are always benefits and trade-offs to consider when looking at two different options. Passive managers believe that it is difficult to beat the market over the long run, and thus, would prefer to go for performance that closely matches the return of an index, and limiting the risks of active management.
On the other hand, Active managers believe that the market can be beaten with detailed research and proficient tools at their disposal over the long-run. Furthermore, there are also fund managers who believe in using hedging strategies or even taking the opportunity to short the market (profiteering when the market is heading down).
Proponents of each believe that their approach is the right one, and that it has the potential to generate the greatest amount of return over the long run. It’s a little like political parties, where both camps see the investment world in vastly different ways and make logical and passionate arguments for their viewpoint.
As an individual investor, we do not have to worry about all the stuff mentioned above. Instead, we can easily enjoy the best of both worlds by seeking a middle ground through the purchase of passively managed funds (like ETFs) and allocating the remaining amount that we have to buy great companies that we have knowledge in and have set our sights on. Ultimately, by blending these two styles, we can potentially take advantage of the benefits of both strategies through the efficient allocation of capital.
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