Active v passive investing: what’s the difference?

By Nicole Webb 09 October 2019 2 min read

So, you've decided to start investing.

That's great, because at Spaceship we think investing is one of the core components of building your long-term wealth. But now what?

Well, it’s important to remember that not all investments are the same. For starters, you should know there are active investments and passive investments. Let's take a closer look.

What is active investing?

Active investing strategies aim to beat the market. Wait, doesn't every investment aim to do that? Yes, essentially, but in the case of active investment, 'beating the market' is a common term that refers to outperforming an index or benchmark.

The most well known index in Australia is probably the S&P/ASX 200, which is made up of the 200 largest Australian companies that trade on the ASX. Think Woolworths, the big four banks, and Telstra, just to name a few.

So, to beat the market, you might try to outperform the S&P/ASX 200.

Active funds management refers to a strategy whereby an investment manager will try to spot the best opportunities and make specific investments in alignment with that strategy.

They might be backed by cutting edge resources such as researchers, databases, and analyst reports, which helps them decide which investments have the best chance of performing.

Perks

  • Returns. Active investing will usually target returns above a benchmark such as the ASX200.
  • Professionally managed. Active investments are managed by a professional fund manager. These managers spend time and effort picking the investments they put into their portfolio. It's their job. This normally includes robust research and processes based on their investment style and strategy.

Considerations

  • Risk. While active management can reap higher rewards, there are no guarantees. And naturally, these investments can be volatile. The fund manager may not achieve the fund’s investment objective.
  • Cost. Because of manager and research costs, active funds often carry higher fees than non-active investments. Management and performance fees are usually reflected in the cost of these investments.

Types of active investments can include share trading, hedge funds, and commodity trading.

What is passive investing?

While active investments aim to outperform, passive investments aim to perform in line with a particular market or sector. The goal is not outperformance of the index but to more closely track the index with low costs.

It’s often considered more of a set-and-forget strategy, as passive investors tend to limit the amount of buying and selling while investing in a market benchmark such as the ASX200.

Passively managed funds do not involve stock picking and extensive research, which means they’re usually more cost efficient than active funds.

Perks

  • Low cost. There's nobody picking stocks, so oversight is more cost efficient. Passive f-funds simply follow the index they use as their reference.

Considerations

  • Narrow investment pool. Passive funds are limited to a specific index or predetermined set of investments, so you may be locked into those holdings.

Types of passive investments can include exchange traded funds and index funds.

Is active investing or passive investing best?

At Spaceship, we think investing is a key tenet of growing your long term wealth. So, if you're thinking of investing, we think you're on to a good thing!

As for which style is best, well that's up to you.  But we think it's important for the fund to reflect your goals and of course your risk appetite. If you're unsure, we recommend you consider seeking professional financial help to explore and discuss your options.

Active v passive investing: what’s the difference?