Passive investing vs. active investing: Which one is right for you?
The way you choose to invest is a personal decision, informed by your goals, risk tolerance and time horizon. As you look to build a portfolio, knowing the difference between active and passive strategies can help guide your decision making.
Passive investing
If you’re someone who prefers a hands-off approach or wants to keep things simple, passive investing might be right for you.
Definition of passive investing
Passive investing is often focused on long-term goals using a “set it and forget it” strategy. Passive investors lean more toward investments that they’ll hold for longer periods of time. While there may be minor maintenance or annual adjustments needed for these holdings, they overall require minimal management or decision-making after the initial purchase. Passive investments also tend to make diversification easier (because you’re working with a longer timeframe) and are generally lower-maintenance and lower-cost.
Read more: Start your investment journey by learning how to buy stocks online.
Popular passive investing options
Many investors use passive investing for their retirement, such as through a 401(k) or other retirement account, and other popular choices include investing in index funds or exchange-traded funds (ETFs). These methods don’t try to beat overall market performance but instead aim to match its movement over time.
Passive investing strategies
An important part of passive investing is being willing to hold onto your investments for the long haul, taking advantage of more time in the market — and, as a result, with comparatively less risk than more active strategies.
When considering passive investments, think about your long-term goals and adjust your strategy accordingly. For example, if you’re getting a late start on your retirement savings, you might need to keep an eye on the performance of your 401(k) and increase your contributions annually to ensure you stay on track. Or you could adjust the risk allocation on a robo advisor tool as your time horizon shortens.
When investing, it’s important to not just consider your willingness to take risks, but also your ability.
Active investing
If you love keeping an eye on the markets and want to take a more involved approach to your investments, you might consider active investing.
Definition of active investing
Where passive investing aims to match the performance of the market, active investing focuses on trying to outperform the market through buying and selling individual securities with a shorter time horizon that requires more attention from the investor — hence, the term "active." This strategy is inherently riskier than long-term, passive investing, since securities tend to be more volatile on a shorter term. Note that you'll likely incur maintenance and trading fees, too.
Popular active investing choices
Active investors may look toward investing in securities with higher risk for the potential of higher reward (for instance, individual stocks, bonds, or other securities as opposed to index funds and ETFs). Past performance doesn't guarantee future returns, but researching the performance of specific investments and overarching market factors might give active investors deeper knowledge as they consider moves to make for their portfolio.
Mutual funds, which are in some ways similar to index funds, can also be active in that they try to outperform the market’s overall performance.
Tip: Keep an eye out for mutual funds and ETFs that are designated as “active,” which often means the fund is managed by a team conducting research on individual stocks and bonds.
Active investing strategies
By researching and analyzing specific stocks or overarching market behavior, active investors try to improve their returns as they buy and sell securities. If you’re interested in active investing, there are many different trading strategies available. A balanced portfolio might mean dedicating a smaller proportion of investments to riskier active trading moves.
What’s right for you?
When investing, it’s important to consider not just your willingness to take risks, but also your ability. Depending on your financial situation and timeline, you might be more or less able to take risks as you pursue your goals. And remember: no investment is risk-free. That’s why, as with any financial decision, your style of investment should be based not just on your risk tolerance, but also your goals and time horizon. And no matter how you choose to get started with your investments, remember your “why.” Choose a strategy that works for you — and try to stick to it.
