Active investing might have some notable advantages but passive investing remains a popular based on its number of participants and the amount or volume of investment flows.
This investment strategy involves less buying and selling while also requiring investors to hold on to their investments to meet their medium-term to long-term financial goals and objectives. Passive investors fundamentally invest for the long haul.
Note that active investing involves an active buying and selling activity on top of continuous monitoring and evaluation of all relevant investment activities.
Pros: Advantages of Passive Investing
The most common example of passive investing involves investing in pooled funds such as mutual funds, unit investment trust funds, exchange-traded funds, and even variable universal life insurance policies, among others. Others also invest in index funds or purchase stocks that are part of a known stock market index. The following are the specific advantages of this investment strategy:
• Simple and Easy: One f the major advantages of passive investing over active investing is that it is simple to understand. The primary requirement is to track a benchmark or an index. It is also easy to do. Most investment options involve investing in pooled funds from known fund managers and financial institutions.
• Minimal Cost: There is also a great selection of investment options to choose from and some of them have low initial investment amount. Investing in pooled funds such as mutual funds and unit investment trust funds have a minimum investment of $200.00 to $500.00. The buy-and-hold philosophy of this investment strategy also means that transaction costs, management fees, and capital gains taxes are minimal.
• Ideal for Beginners: Both its simplicity and low cost make passive investing ideal for individuals who do not have the relevant expertise to analyze assets and securities nor the time to learn and monitor the different facets of their investments. Decision-making is also confined to choosing which fund to invest in.
• Long-Term Growth: The buy-and-hold philosophy can easily be translated to an invest-and-forget approach to investing. Passive investing is ideal for those who want to invest for the long haul. These include individuals who are building their retirement funds or preparing for the education of their children. Note that index funds or pooled funds consisting of equities have shown to increase their value historically.
• Diversification Options: Investors who wish to diversify their investment portfolio can do so by investing in different funds that include a good mix of high-risk and high-return funds such as equity funds, average-risk and average-return funds such as bond funds, or low-risk-and low-return options such as bank deposits.
Cons: Disadvantages of Passive Investing
Of course, because it involves a less hands-on approach to investing, passive investing has notable drawbacks and limitations that can make active investing a more enticing approach for some. Take note of the following disadvantages:
• Lacks Flexibility: Passive investing does not have the flexibility of active investing. It has less room for tweaking an investment portfolio to respond to conditions and the outlook of relevant financial markets. Diversification options are also limited to fund selection. It cannot take advantage of or minimize losses from short-term market changes.
• Smaller Returns: Another notable disadvantage of passive investing, especially when compared with active investing, is that it has a smaller earning potential. Investing in pooled funds will not outperform benchmarks or indices in theory because its goal centers on tracking market performance. The long-term outcome of this investment strategy also makes it unideal for those who are looking for quicker returns.
• Limited Control: This approach to investing can also be described as an indirect form of investing. Passive investors do not have the option to select specific assets or securities because their choice is limited to a selection of static asset classes or pooled funds designed by fund managers or financial intermediaries.
Considering a Passive Approach to Investing
Remember that passive investing remains more popular than active investing as evident from the number of its participants and volume of investment flow because of its aforesaid advantages. It remains an ideal investment route for both beginners, as well as to those who do not have the time and risk appetite to deal with the demands of an active approach to investing.
Evidence reveals that it also outperforms active investing when it comes to providing returns, especially when factoring in long-term investment performance. Of course, before investing, it is important to yourself pertinent questions before you start investing to determine or revisit your financial goals and objectives and evaluate your risk profile.