A starter’s guide to active and passive investments
Active and passive investments – they’re two very different ways of investing that come with their own pros and cons. Here’s our guide to both styles, to help you decide what will work best for you.
By Richard Pearson
Follow the market or trust the pros
When it comes to the passive style of investing, your investments are following market performance. Your investment value moves with the ups and downs of the top companies’ performance in any given area.
On the other hand, with the active style of investing, you have a fund manager actively moving your funds around. They use their professional judgement to decide which companies to invest in and how to move money around to achieve the fund's objectives.
Let the market do the work with passive investment
Thomas Stokes, Investment Director with Aviva Investors, says this type of investing is “all about following the market, rather than trying to beat it”. Usually this ‘market’ is a group of recognised companies that go up and down in value over time.
Less exciting? Perhaps. But potentially more reliable, and usually cheaper. These sorts of investments may suit you more if your financial markets know-how is a little so-so, or you prefer to spend less on fund charges. Thomas says: “Passive investing is more simple and less onerous than active management, so it’s a great way to keep costs lower”.
The pros get busy with active investment
“Active investment means investment professionals looking after the day to day”, says Thomas. Your money is in the hands of a fund manager. Their mission? To make more than you would from a passive fund by using their financial prowess to decide where your money’s invested.
When a fund manager makes the right choices, the investments can generate better returns for you. Because the fund manager has to work harder to make this type of investment successful, they may charge higher fees than those you get with passive investment.
Invest sustainably with either style
Both active and passive investing give you the chance to make sure your money is going to companies that have ESG principles (Environmental, Social and Governance) in place, but protecting the planet while investing has its own challenges.
Passive investments can be nudged in a green direction
Traditional passive funds don’t tend to follow ESG standards. But given the growing concerns around climate change and the need to take immediate action, some asset managers have found a way to invest more passively, while tilting more investment into companies with better ESG credentials. So it’s possible to make sure your money is going into sustainable funds, even if you’re investing passively.
A fund manager knows the sustainable signs to look for
In the case of a fund with ESG principles in the active style, your fund manager will research the green credentials of all the companies they invest in so they can easily move your money into the most eco-friendly ones.
You can mix the two together
Thomas says: “If you can’t decide whether active or passive is the right way to go then you can always consider having a blend of the two to have the best of both worlds”. There’s no right or wrong answer to the question, it all depends on what suits you best.
No investment style can guarantee success. With the active style, your money is in the hands of a fund manager. And they’re trusting their judgement to pick the right investments for you. If you choose passive investment, you’re still reliant on how well those top companies in the market perform.
Thomas says there are four main factors to think about when making investment decisions:
- Cost – what are the fees and charges for the fund?
- Performance – how has the fund performed in the past? Remember this is no guarantee of future performance
- Risk – How risky are your investments? What do you stand to lose?
- ESG – What are the ESG credentials of the companies you are investing in?
Choosing how to invest means finding a balance between these four factors that you feel comfortable with. Whichever style you choose, remember investing by its very nature is risky. The value of your investments can always go down as well as up, meaning that you could get back less than you put in.