There are three basic principles of making money in the money market using active and passive investing, i.e., finding undervalued opportunities, investing broadly through long-run economic gains, and keeping the costs as low as possible.
However, the choice of investing in an active or passive style can affect your investment results significantly. This stirs a hard heated debate among investors as they discuss how active management compares to passive investing – a conversation that features widely in the financial industry, especially when constructing investment portfolios. This round-up breaks down these concepts and explains the importance of using both strategies to grow your portfolio.
Active investing is an investment strategy that involves continued buying and selling of the most attractive assets. As such, active managers monitor the performance of different investments to identify and exploit profitable conditions. The goal is to outperform the market or beat the standard benchmarks to achieve better returns on a short-term basis.
Unlike active management, passive investing is a long-term strategy that capitalizes on the upward market trend over the years. It’s a buy-and-hold strategy, where investors seek to benefit from long-term returns as opposed to short-term price fluctuations.
As a passive investor, your goal is to build a portfolio of stocks in a particular market index. This means passive investors avoid the frequent transaction fees, limited performance, and high risks associated with active investing.
Active vs. Passive: Which strategy is better?
Over the past few years, assets have been shifting from active to passive investing,as evidenced by the growth of Exchange Traded Funds (ETFs) and Mutual Funds (MFs). Passive offerings continue to dominate the market share over their active counterparts- a trend seen not only in the US but also in Europe.
However, this does not mean that investors should skimp on active management. One advantage of being an active investor lies in the potentially high gains, should you outperform a specific index.
Active managers who are keen to improve the risk-adjusted returns can be beneficial in a time of unprecedented market stress. From an analytical perspective, the returns of actively invested funds trail those of those passive investing. This can be attributed to the fact that passive investing outperforms active investing in the long haul.
Passive investing is not limited to the traditional asset classes
If you’re a cryptocurrency investor, you can also benefit from the passive management of your digital assets. In recent years, several start-ups have been launching their versions of cryptocurrency index funds.
A good example is Bitwise HOLD 10 – a fund designed to hold the top ten digital currencies based on the market cap. Although these crypto startups track indexes the same way ETFs do, it’s worth noting that they are not regulated.
Just like the stock market, there is no guarantee that professional crypto traders or fund managers can be good enough to pick stocks and beat the market consistently. In fact, cryptocurrencies are extremely volatile assets, which make it more difficult to profit from a short-term investment.
This is why choosing a pool of cryptocurrencies that reflect the overall market performance is a good investment for both individual and institutional investors.
Pursuing the best of both worlds
A good number of successful investors embrace a mixed approach by combining aggressive and conservative strategies. When the stock market is volatile, active strategies tend to be more beneficial.
On the other hand, when securities within the market are moving in unison, passive investing is the way to go. As such, investors can benefit from pursuing the best of both strategies. Simply put- by understanding the market conditions, one can make informed decisions and leverage the most valuable opportunities in both.
When pursuing this approach, always remember that successful active management is more difficult to achieve within select markets and asset classes. Therefore, it makes sense to veer into an all-passive portfolio for asset classes that have historically proven more profitable.
In closing, it’s important to note that investors can make money by taking any of the two paths. Passive management is ideal for investors with long-term financial goals, while active management is for those looking to pursue profitable market opportunities on a short-term basis. The choice depends on your financial goals, priorities, and investment timelines.