Passive and Active Investing: Benefits and Weaknesses

Passive investing and active investing are both widely used in the TradersHome Broker market for their specific benefits and disadvantages. Being familiar with such things will definitely help you succeed in investing. Read on!

Passive Investing

Passive investing means you’re investing for the long haul. Such kind of investors limits the amount of buying and selling within their TradersHome Review portfolios, making this a very cost-efficient way of investing your money.

The technique requires a buy-and-hold mentality, and that means trying to resist the temptation to react or anticipate the stock market’s next moves.

Perhaps the best example of the passive approach is to buy an index fund that follows one of the major indices like the Dow or the S&P 500.

Whenever these indices switch up their holdings, which is by selling the stock that’s leaving and buying the stock that’s becoming part of the index.

When you own tiny pieces of thousands of stocks, you may earn simply by participating in the upward direction of corporate profits over time via the overall stock market.

Successful passive investors keep their eye on the prize and ignore short-term setbacks and even steep downturns.

Active Investing

As the name suggests, active investing take a more hands-on approach and requires a person to assume the job of a portfolio manager. The goal of active money management is to beat the stock market’s average returns and take full advantage of short-term price fluctuations.

It involves a much deeper analysis and the expertise to know when to turn into or out of a particular stock, bond, or any other asset. A portfolio manager usually oversees a team of analysts who look at qualitative and quantitative factor.

Active investing requires confidence that whoever’s investing the portfolio will know exactly the right time to buy or sell. Successful active investment management pushes you to be right more often than wrong.

Strengths and Weaknesses

Passive Investing

The key benefits of passive investing include:

  • Ultra-low fees – there’s nobody choosing stocks, so oversight is much cheaper. Passive funds merely follow the index they use as their benchmark.
  • Transparency – it’s always obvious and clear which assets are included in the funds.
  • Tax efficiency – their buy-and-hold strategy doesn’t usually result in a massive capital gains tax for the year.

Meanwhile, weaknesses would include:

  • Limitations – passive funds are limited to a specific index or predetermined set of investments with little to no variance. You are locked into those holdings regardless of what happens in the market.
  • Small returns – passive funds will pretty much never beat the market, even during downtimes. It’s hard to imagine passive funds posting the big returns that active managers crave unless the market climbs stellar heights.

Active Investing

Advantages of active investing include:

  • Flexibility – active managers aren’t required to follow a specific index. They can buy those “diamond in the rough” stocks that they believe they find.
  • Hedging – active managers can also hedge their bets using various strategies such as short sales or put options. They can also exit specific stocks or sectors when the risk becomes too much.
  • Tax management – even though this strategy could trigger a capital gains tax, advisors can tailor tax management techniques for individual investors.

Meanwhile, some pitfalls include:

  • Very expensive – fees are higher because of all the active buying and selling transactions, which triggers transaction costs.
  • Active risk –active managers are free to buy any investment they think would bring high returns, which is good news if the analysts are right but nightmare-ish if they are wrong

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