When discussing your investment portfolios, a dilemma often occurs: you want to make money from your investments, but you’re not sure which approach is best. Specifically, investors wonder whether an active or passive investment strategy is the right one for them. Do you put your investments in the hands of a manager or analysis team in hopes that you’ll beat the market? Or are you willing to go with the flow and ride along with the market by following an index fund, no matter how it does? How does either management strategy work, and what does it mean for you as an investor?
Typically, a portfolio that follows an active investment strategy is one whose goal is to do better than an index fund, like the S&P 500. It’s more of a hands-on approach, and usually requires a fund manager and a team to perform concentrated analysis and consider a number of factors, such as the ones below:
- What is trending in the market?
- What is the state of the current economy?
- What is the status of emerging markets?
Pros and Cons of Active Investment
The biggest benefit to an active investment management style is that you could potentially outperform a standard index. Essentially, this means better rates of return. There’s also greater flexibility in an actively-managed portfolio, as fund managers don’t have to rely on following an index.
Conversely, there are many in the industry who say that outperforming the market is an exception to the rule – not the rule. As the saying goes, “To err is human…” and while it’s a good day when the portfolio manager is right, it’s not a great feeling when the stocks they picked don’t perform as they were expected. You’re also more likely to incur higher fees with an active investment strategy; therefore, you’ll be getting diminished returns if fees are unnecessarily high, or are not justified by the performance.
Unlike active investment, a passive investment strategy follows the trajectory of an index and doesn’t need an entire management team to research, analyze, and track it. If your passive investment portfolio follows the S&P 500, for example, and tomorrow morning you hear that the S&P 500 rose 3%, you’ll know that your portfolio also made 3%. The same is true for any losses.
Pros and Cons of Passive Investment
If you’re new to investing, a passive investment style may best fit your needs. It’s likely that you won’t experience massive returns with such a strategy, but you’ll also know exactly how your portfolio is doing at any given time because it’s simply following the market.
Perhaps the best asset to a passively-managed portfolio is that there’s little room for human error. However, there are fewer fees associated with passive investments and generally such portfolios are considered to be lower cost than active management.
Should I Follow An Active or Passive Investment Strategy?
As we’ve outlined, there are pros and cons to either strategy. Some financial advisors adhere to combining both strategies over the lifetime of a portfolio. Talk to a Chatterton & Associates advisor about which financial goals are most important to you. It’s also a good idea to revisit your investment strategy at least once a year to make sure that you and your advisor are on the same page. If you have any questions regarding which investment strategy is right for you, contact us today. Our advisors will help you decide whether an active or passive investment strategy will fit your specific needs.