This month, written by Tom Day
In the world of investing, there are two primary styles that can be utilised by retail investors: passive investing, and active investing.
Active investing is a strategy where investors aim to outperform the market by actively buying and selling assets. This approach relies heavily on market research, analysis, and the judgment of portfolio managers or individual investors. Active investing often involves frequent adjustments to the portfolio based on changing market conditions, economic indicators, and company-specific factors.
Passive investing, on the other hand, aims to replicate market performance by tracking a benchmark index, such as the S&P 500 or FTSE 100. This approach is built on the premise that markets are generally efficient and that attempting to outperform them is both costly and risky. This strategy involves purchasing a portfolio of assets that mirror the index and holding them over the long term.
Passive investing is typically cheaper than active investing due to its simplicity and low management requirements. Passive strategies often involve little to no trading, which significantly reduces transaction costs compared to active strategies, which often involve frequent buying and selling of assets. Passive funds also don’t require a team of analysts or portfolio managers to research and make decisions, whereas active funds rely on skilled professionals to identify opportunities and adjust portfolios, leading to higher management fees.
Both have their merits and drawbacks, depending on market conditions, economic cycles, and an individual’s goals. You can pretty much guarantee the costs associated with investing, but you cannot guarantee performance, which can sway the favour towards passive investing for many people.
The choice between active and passive investing is influenced not only by individual preferences, but also by broader market dynamics and economic cycles. Historically, the popularity of these strategies has alternated based on conditions in the financial world.
For example, in highly efficient markets, where prices accurately reflect all available information, passive investing tends to become the dominant choice. On the other hand, during periods of inefficiency or when major market disruptions occur (e.g., sudden technological advancements or geopolitical shocks), active investors can find opportunities to exploit these anomalies, which passive investors would not benefit from. The flexibility and adaptability of active investing can become particularly valuable during times of uncertainty.
This has been the case recently, as global passive funds have been very exposed to the turbulence brought on by President Trump’s tariff policies. The US forms a massive part of the global stock market, with the “Magnificent 7” making up a large portion of this. As a result, pure passive investors (such as those who solely hold an S&P 500 tracker fund) have not been shielded from the recent volatility and may be overexposed to some markets.
Further to this, during periods of economic expansion, active investing can thrive. Bull markets (when the market is in an upward trend) often present numerous opportunities for skilled investors to identify undervalued assets or capitalise on sector-specific trends. Active management can also benefit investors during bear markets (when the market is in a downward trend), as they are able to identify sectors, industries, or companies likely to be more resilient during economic declines and shift their portfolios away from underperforming or vulnerable assets.
Ultimately it comes down to personal preference, as both active and passive investing each have unique strengths and weaknesses, making them suitable for different types of investors and market conditions. While active investing provides opportunities for customisation and potential outperformance, it comes with higher costs and risks. Passive investing, on the other hand, offers simplicity, lower fees, and consistency (as you will effectively get the market average of performance), but lacks the flexibility to adapt to market changes, unless it forms part of a broader portfolio with some level of active asset allocation.
If anything, recent global events highlight the importance of regular reviews of your portfolio, as the best thing 10 years ago is not necessarily going to be the best thing today, and being able to adapt and change based on market conditions is only going to be beneficial in the long term.