What Is the Difference Between Active and Passive Investing?

Most investors leverage either passive, active or somewhere-in-between investing strategies. They're all strategies, and not one is better than the other—rather, they're just different.

The differences between active and passive investing, explained

Let's unpack each

Passive Strategy

Passive strategies are long-haul investments. The goal is to minimize spending costs while maximizing profits. You do this by buying securities with the intent of holding them for years, or even decades. While the strategy can involve individual securities, generally it means purchasing index funds and ETFs.

Many investors believe that this method allows them to cut down on taxes, commission and purchasing costs. It may also cut down on the risks of trying to time the market.

Active Strategy

Active strategies, on the other hand, involve trading stocks much more frequently. Typically, day traders and those who hire portfolio managers use this strategy. That's because success hinges upon deeper focus on market trends. When correctly implemented, this method can lead to massive short-term gains. However, this strategy is also inherently riskier, as a few bad calls can wipe out a portfolio overnight.

Typically, a robust portfolio will blend both strategies. The real question for most investors is not which approach they want to take. It's what percentage of their portfolio they want to dedicate to each.

What this means for you

Before you invest, you’ll want to answer a few questions about your personal situation. These will help you determine the best strategy to suit your needs. For instance, you’ll want to decide how your approach fits in with your risk tolerance.

Your investment time horizon is another critical consideration – do you want children soon? Are you planning on purchasing a house? Knowing when you’ll need to have a nest egg can help you narrow down which strategies suit your financial needs.

After you’ve taken stock of your personal situation and decided whether you want to invest passively or actively, it’s time to look at a few different investment strategies, such as the following.

  • Growth investing, which focuses on putting money into companies you believe will be valuable soon  
  • Value investing, which looks to invest in undervalued equities for the long-term  
  • Income investing, which provides a steady source of revenue 
  • Momentum investing, which involves hawkishly watching the market and looking to ride pricing trends
  • Dollar-Cost Averaging, which lowers your price-per-share costs over time by not trying to time the market 

There is no one right investment strategy, nor is there an “easy” strategy. Regardless of your situation and diversification, you’re likely to come across losses in your portfolio. The trick is to find a method that earns enough interest to compensate for lost funds – and then some.

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