Active vs Passive: Which Investing Strategy is Best?

Published by Bob Gustafson

Active vs. Passive Investing

The debate of active vs passive investing has been raging since the 1970s. Proponents on both sides offer up what they believe to be objective evidence that supposedly supports their respective positions. If you are not that familiar with the active vs passive debate, let me briefly explain.

Prior to the 1970s, there were stock pickers. Those individuals were picking portfolios on an active basis. Then, indexing became popular and experts realized by using computers to benchmark they got some good returns. This practice led to index funds. And the passive strategy was born

Active vs passive investor views

Active investors believe stock prices react to information slowly enough to allow a savvy investor to outperform the market even with the higher costs associated with transactions and research. In other words, they actively try and beat the market. Active management is still the most predominant form of investing in today’s market.

Passive investors on the other hand believe that the stock market is efficient and therefore stock prices are always fair and quickly reflective of information. Passive managers don’t try to beat the market. Instead, they try to match its performance by investing in low-cost passive forms of investments like index funds or ETFs (Exchange Traded Funds). Passive investors believe this type of strategy strategies can get you to where you want to be in a more efficient way.

A third alternative is to develop a method to allocate a mixture of both strategies.

Should you manage your own portfolio?

Unfortunately, many people fall into the trap of trying to actively manage their own accounts. Why? Well, we could spend years discussing this but suffice it to say for the sake of argument that humans want to feel like they can control their future. Thus, we look for ways to feel in control (even when we are not).

Actively managing your investment portfolio is one way to create this sense of control. But don’t fall into the trap unless you’re financially savvy and have the time to stay on top of things. If you’re not, then it’s important to leave it up to an expert. The other option is to “set it and forget it” and take a passive approach!

If you’re an individual investor with a diversified portfolio, you can have an active money manager or a passive money manager and this scenario will bode better for you than if you try to actively manage your portfolio on your own. 

Which type of investor are you?

As an independent fee-based advisor, I’ve been analyzing the data on the active vs passive investing debate for decades and feel that both forms of investing can make sense. Personally, I use an active/passive approach, which is a hybrid of the two methodologies.

With that being said, the key to any strategy, whether it be passive, active or a hybrid, is to:

These variables will play a significantly greater role in the overall return of your portfolio than an active or passive investment strategy ever will. Keep your eye on what is important and don’t lose sleep over whether or not you should maintain an active vs passive investment strategy.

Learn more by listening to our podcast below. And let us know if we can help you create an investment portfolio that meets your financial goals.