Passive Vs Active Investment Strategy – Which Is Right for You?

Posted on 11th April 2023

Maxim Manturov, Head of Investment Research at Freedom Finance Europe, explores passive and active investment strategies for investors

Investing has become increasingly popular in recent years, likely a result of the pandemic and the growing interest in start-ups and ESG-friendly businesses. As more and more investors without a background in finance enter the market, it’s crucial that people understand the different methods and strategies that can be implemented to get the best potential on their return.

Passive and active market strategies are two different approaches that investors can use to manage investments. Choosing between the two depends on the investor’s individual goals, risk tolerance and investment philosophy.

The passive strategy is suitable for investors wanting to match market performance with minimal effort and low commissions, such as beginners or investors who cannot devote much time to researching markets or individual stocks.

Alternatively, an active strategy suits investors who are willing to take more risks to potentially outperform the market. Active strategies exposed investors to specific risks that require high skill, experience and understanding of the market so it is often most suitable to experienced investors with some financial cushioning.

Passive market strategy

A passive market strategy involves investing in a diversified portfolio of stocks that track a specific market index, such as the S&P 500. This strategy is based on the belief that it is difficult to consistently outperform the market, so the investor seeks to match the results of the market by investing in an index fund or exchange-traded fund (ETF). It requires minimal effort and usually incurs lower costs than active strategies.

Passive investment methods aim to avoid the commissions and limited productivity that can arise from frequent trading. Unlike active traders, passive investors do not seek to profit from short-term price fluctuations or market timing, instead, it tries to replicate market performance by creating well-diversified portfolios of individual stocks.

Advantages:

Lower commissions and costs due to minimal trading activity and management
Diversification and access to all markets rather than individual stocks
Generally lower tax implications because there are fewer purchases and sales
Proven ability to work successfully in the long term
Requires minimum effort to implement

Disadvantages:

Limited opportunity to outperform the market, as investors receive only market returns
There is no active management to respond to market changes or adjust portfolios accordingly
May not be suitable for investors with specific investment objectives or needs

Active market strategy

An active investment strategy involves actively buying and selling stocks to outperform the market. This approach requires a great deal of research and analysis to identify undervalued stocks or market trends, and investors may use a variety of techniques such as technical and fundamental analysis. Active strategies can be complex and incur higher fees and costs.

Active investment is great for investors seeking higher returns, however, there is a higher risk of significant loss due to market volatility.

Advantages:

Potential for higher returns through effective investment decisions and market analysis
Flexibility to adjust investment strategies in response to market changes or events
Opportunities to invest in individual stocks, industries, or sectors

Disadvantages: