When it comes to investing, there’s a vast array of options to choose from. One of the key distinctions you’ll encounter is between passive and active investments. Here’s a breakdown of how each approach works and their pros and cons, to help you decide which might fit your strategy.

Active investments: hands-on management

Active investments involve making strategic decisions about when to buy and sell. This can be done personally or by investing in a managed fund, where professional fund managers make decisions on your behalf.

Managed funds pool your money with other investors and aim to outperform benchmarks like the S&P/ASX 200 by analysing opportunities and responding to market changes.

Advantages of active investing

• Delegation to professionals who monitor markets and make informed decisions.
• Flexibility to capitalise on short-term opportunities and react to market changes.

Disadvantages

• Higher fees due to operational and management costs.
• Returns can be inconsistent, even with professional oversight.

Passive investments: a long-term approach

Passive investments focus on tracking the market rather than outperforming it, with minimal trading activity to keep costs low. Popular examples include Exchange-Traded Funds (ETFs), which replicate the performance of a specific index or sector.

The strategy centres on “buy-and-hold”—keeping investments steady through market ups and downs to build wealth over time.

Advantages of passive investing

• Lower fees because of fewer trades and simpler management.
• Broad market exposure without the need to select individual investments.

Disadvantages

• Performance is tied to the market index, with limited potential to outperform.
• Limited control over the specific assets held within an ETF or index fund.

Which approach is best?

Both passive and active investments have their benefits and drawbacks, and whether you’re drawn to one over the other often comes down to personal preference. But there’s nothing stopping investors from taking advantage of both kinds of investments.

A popular way to go about this is the core-satellite approach. This divides your portfolio into majority passive investments (your ‘core’) and a smaller number of actively managed funds or direct investments (your ‘satellites’).

The point here is to gain broad market exposure while not closing yourself off to funds that have the potential to outperform the market, particularly if they’re able to spot those diamond-in-the-rough stocks that others might have overlooked.

Of course, when picking investments, you’ll have to consider whether they align with your goals, investing timeframe and appetite for risk. And while looking at past performance can be useful, remember that it shouldn’t be treated as an indicator of future performance.

If you are still unsure, it may be wise to consult with a financial adviser to determine the mix of active and passive investments best suited to your risk tolerance and wealth goals.

Written and accurate as at: November 14, 2024

This information provided in this article is general advice only and has been prepared without taking into account your own objectives, financial situation or needs. Before making a financial decision based on this advice, you must consider whether it is appropriate in light of your own needs, objectives, and financial circumstances, and where relevant, obtain personal financial, taxation or legal advice. Where a financial product has been mentioned, you should obtain and read a copy of the Product Disclosure Statement (PDS) prior to making any decisions about whether to acquire a product.