Before we go into deciding what strategy we prefer when investing, we must think about whether we want to be a passive or active value investor. “What?” You must be thinking to yourself. What is the difference between the two?
The Short Answer
To keep it simple and short, passive investing is investing by tracking the index you chose. For example, you might be a Malaysian-based investor and you want to be a passive investor. You can simply invest in all the companies within the Kuala Lumpur Composite Index (KLCI) or buy an ETF/ Mutual fund that tracks the performance of the KLCI. In this way, your performance will be similar to whatever the market generates. You will be able to track the market performance without spending much brain power analyzing which stock to buy.
Active investing, on the other hand, is the form of investing where you actively decide on which stock to invest in, to maximize your returns. Theoretically, being an active investor allows you the opportunity to outperform the market.
What Are The Pros And Cons?
So, which one should you choose? Here is a list of benefits and risks of being an active or passive investor. We hope that it would give you a better idea on which style of investing is more suitable for you.
- Simplicity – You can invest easily by following the index
- Saving time – You do not have to spend hours researching which stocks to buy
- Diversification – You can buy a well-diversified basket of stock
- Low costs – Investing directly in passive index funds might save you in commissions and management fees
- Potential to beat the market
- Higher flexibility – You can change your investment style to suit the market condition.
- Greater peace of mind – As you only select stocks that you are optimistic about, you would generally feel better about your portfolio.
- Guaranteed to underperform the market (After fees and commissions)
- Lack of flexibility – You have to invest in stocks that you find questionable
- Typically higher cost
- More time consuming – You will need to spend considerable time in researching companies
- You might still underperform the market after all the effort
Hybrid Can Be A Style Too
If you are still caught on the fence, you might be glad to know that, there is no rule against being both at the same time. In fact, many investors do combine the two forms in their portfolio. They might have a portion of their portfolio invested in index funds while they allocate another portion to find “market-beating” opportunities.
Interestingly, a report by CNBC shows that 60% of active emerging markets funds outperformed its passive peers, provided their fees were not excessive. This showed that active investing can work in some instances.
However, the trend seems to be going the other way globally. Over the last decade, more and more capital has been poured into passive funds compared to active funds.
As individual investors, this is the first decision we should make. Once we know if we are committed to be an active investor or simply want to be a passive investor, we can plan and construct the best possible portfolio for ourselves.
What Is Your View?
After comparing the two form of investing, what is your verdict? What will you choose: Passive or Active?
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The information provided is for general information purposes only and is not intended to be any investment or financial advice. All views and opinions articulated in the article were expressed in Stanley Lim’s personal capacity and do not in any way represent those of his employer and other related entities. Stanley Lim does not own any companies mentioned.