Passive Investing vs. Active Investing—Which Is for You?

Guideline for which investing route is right for you, your risk tolerance and your preferences

You’ve probably heard a lot about a “passive” or an “active” investment strategy. Which one is right for you?

Passive investing is when you purchase a basket of every stock in an index ( i.e., a subset of the market) through an index mutual fund or ETF mutual fund. Using a passive approach, the goal is to match the performance of the market you’re investing in.

Active investing is when a manager attempts to beat the market’s performance (or that sector of the index market) by buying and selling positions in that market using research, forecasting, experience and opinions to guide their trades.

So, which one is it? Well, it’s not so simple.

Passive investing is gaining popularity -- these funds are traded infrequently, have far lower management fees and are more tax advantageous.But while some favor passive investing because it’s less expensive and requires less attention, others trust active investing more because managers can add “alpha” (performance) by their research, forecasts and experience.

What do the experts say?

In 2007, Warren Buffet added more fuel to the passive-or-active-investment debate when he made a $1,000,000 bet with a hedge fund saying that passive investing was better for the everyday investor. That’s right: the world’s most famous active investor suggested passive investing for the majority of us. Why? Because Buffett knows that index funds are inexpensive and not tied to the success of one single entity. He also knows that they will outperform active managers who have to outperform the markets enough to make up for their fees, tax inefficiencies and emotional turmoil of their trades.

"The trick is not to pick the right company. The trick is to essentially buy all the big companies through the S&P 500 and to do it consistently." - Warren Buffett

Turns out Buffett won the bet and donated the $1,000,000 to charity (of course he did!).

Lastly, while many believe there’s a cyclical nature to how active and passive investment strategies perform,active management typically out-performs passive management during down markets. Active managers have captured outperformance as the market recovers and passive management tends to outperform active during up markets.

Ultimately, the choice is up to you. There’s no right or wrong investment strategy. It depends on your goals and how involved you plan to be in your investments.

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