Find out what is Active and Passive Investing, and common misconceptions between the two.
For many people who are new to investing, the investment world is a complex environment littered with difficult definitions, complicating economic concepts and hard to understand financial jargons. Compound this problem with the numerous opinions and advices out there offered by financial “experts” and it is not difficult to see why many who are new to investing find it difficult and confusing to get started.
The DollarsAndSense.sg editorial team can relate to the problem. After all, we too are living in an Internet world whereby a google search on “investing” will churn out millions of search results in a split second. We want to make this “investment journey” easier by bringing you the key essence of what you need to know for investing – “one bite-sized article at a time.”
Before you start investing, it is important first to understand the basic approach that you wish to take, Active Investing or Passive Investing. What are the main differences between the two approaches, and which is most suitable for you as an investor.
Active Investing
Active Investing is the most common form of investing practiced by fund managers around the world. The core aim of these fund managers is to achieve returns that outperform the benchmark index.
‘Benchmark Index’ – a gauge of the performance with regards to a certain stock market. In the index, it consists of stocks depending on the criteria set by the country’s stock exchange. Investors and fund managers will typically use it to compare the performance of their portfolio.
By actively investing, the fund managers are exploiting what they believe are inefficiencies in the markets by buying and selling stocks at their discretion. The kind of strategies available to them includes short-selling, event driven matters and macro-selection. When fund managers actively invest, they have to be constantly aware of the volatilities in the markets and adjust accordingly to it.
In the local context, some of the investment products that have an active investing element will include unit trusts. Unit trusts are usually offered through banks or financial services websites. We would like to advice potential investors to first understand the investing objectives of each unit trust before putting their money in. Some insurance policies such as whole life policies and investment-linked plans will include investments into various type of unit trust. If you have such a plan, that means you may already be an active investor without even realising it.
Individual Investors who are frequently buying and selling stocks in their portfolio can also be categorised as active investors.
Passive Investing
Passive Investing is a form of investing that uses the benchmark index as a gauge for returns. Advocates of passive investing believes that markets are efficient in the long run so there isn’t really much of a point trying to outperform the market (ie: attempt to earn additional returns on top of what the market is giving). Passive investment products usually track the benchmark index.
Take for example, in local context; the STI ETF (Ticker: ES3) is an exchange-traded fund that tracks the Straits Times Index. The STI ETF has 30 of Singapore’s blue chip companies in its holdings. The ETF is managed by State Street Global Advisors, which is the fund manager. Unlike fund managers who actively invest, the role of these passive fund managers is to handle subscriptions and redemptions of the funds and etc. Passive fund managers do not actively buy and sell shares.
Common Misconception about Passive Investing
As retail investors, when we entrust our wealth to fund managers by subscribing into a unit trust, we may think we are passive investors since we are not actively involved with the process of selecting and trading stocks. However this investing strategy itself is not a passive approach because the fund manager is essentially appointed to buy and sell stocks on our behalf and at his discretion, as long as it is within the fund’s guidelines. This effectively, is an active investing approach.
Simply buying into an ETF does not automatically make one a passive investor, not if the person is buying into the ETF with the intention of trying to time the market (ie: buy when they feel prices are low, sell when they feel prices are high). An investor who enters into a trade looking to time the market is taking an active investing approach.
Whether you are totally new or have already been investing for sometime, we hope that you find this article useful for getting started or realigning your own personal approach to investing. There are a lot more about investing that we will be covering so do continue to visit DollarsAndSense.sg. You can also follow us on Facebook to stay connected with our articles and other exciting stuff that we have lined up in the coming few weeks.
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