If you've ever wondered what the difference is between an active or passive investment fund, understand that they're not the same, and one may fit your investing situation better than the other.
In general, actively-managed funds aim to outperform the market as measured by a specific benchmark, such as the FTSE 100 index of the UK’s biggest companies. Passive funds, however, such as Exchange-Traded Funds (ETFs) and tracker funds, simply mirror the investment holdings of an index and its performance.
Stable markets bring large levels of reassurance, and it is when amateur investors tend to invest the most money.
Passive portfolio management mimics the investment holdings of a particular index in order to achieve similar results, also known as the index fund management.
The portfolio is designed to parallel the returns of a particular market index or benchmark as closely as possible. For example, each stock listed on an index is weighted. That is, it represents a percentage of the index that is commensurate with its size and influence in the real world.
The creator of an index portfolio will use the same weights.
The main risk of investing via a passive fund is that you might over-expose yourself to a small number of sectors or stocks. Because passive funds are skewed to automatically follow the most well-performing opportunities, their portfolios will often contain a small number of high-performing investments.
Should these assets suddenly take a turn for the worse as we have seen recently weeks, it can quickly cause the overall investment portfolio value to plummet.
Whereas, more experienced and cash affluent investors tend to see unstable markets as a key time for significant investment. This is where the ‘active portfolio management’ is seen as the most effective.
Active portfolio management focuses on outperforming the market in comparison to a specific benchmark such as the Standard & Poor's 500 Index.
The investor who follows an active portfolio management strategy buys and sells stocks in an attempt to outperform a specific index, such as the Standard & Poor's 500 Index or the Russell 1000 Index.
Active versus passive investing strategies have often been framed as an all or nothing proposition.
Each approach comes with its benefits and drawbacks. A good time when to use and when not to use.
Let’s assume a portfolio worth £100,000. In the first case, the portfolio is completely invested in passive management strategies which cost 0.5% annually. This amounts to £500 in a year. This means that whatever the strategy yields as returns at the end of the year, the aforementioned cost will reduce those returns to that extent.
Let’s assume that passive portfolio management yields 3% returns for the year. In absolute terms, the passive strategy would result in a total portfolio value of £103,000. But when we adjust this value for the expenses associated, the passive strategy results into the total portfolio value of £102,500.
Benefits of passive investing:
If you want a ‘what I see is what I get’ investment strategy then you want to be looking towards a wealth manager who can create a passive portfolio. This will provide you with the biggest safety and reassurance any fluctuation in portfolio value will be minimal.
Let’s use the same portfolio worth £100,000. The portfolio is completely invested in active management strategies which cost 2.5% annually. This amounts to £2,500 in a year.
Let’s assume that active portfolio management yields 8% returns for the year. In absolute terms, the passive strategy would result in a total portfolio value of £108,000. But when we adjust this value for the expenses associated, the passive strategy results into the total portfolio value of £105,500.
Benefits of active investing:
If you want a ‘strong and opportunity growth’ investment strategy then you want to be looking towards a wealth manager who can create an active portfolio. This will provide you with the biggest levels of portfolio growth and opportunity.
Whichever option you choose, or whether you decide to invest in both active and passive funds, you must accept that your investments can still fall in value as well as rise and you might get back less than you invest.
Are you struggling to manage your investments?
It can be daunting knowing where and how to place your portfolio in times of certainty and uncertainty.
Our in-house specialists have 20+ years of experience when investing in varying markets with various levels of confidence. You can schedule a 15 minute consultation to better understand which strategy is best for you.