Active vs. Passive Investing: Your 101 Guide

Lately in HerMoney’s InvestingFixx group, I’ve noticed a lot of questions coming in on the topic of active vs. passive investing — specifically what it means to be a passive vs. active investor. 

Here’s the skinny: Essentially, when you’re a passive investor, someone or some investment vehicle is doing the work. (Either a financial advisor is managing your money with little input from you, or you’re investing in mutual funds or ETFs and letting those vehicles determine your exposure.) But when you’re an active investor, you’re spending time every week researching companies and the economy, picking your own investments and managing your own portfolios. 

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From there, it gets a little squishy: A passive form of active investing is choosing actively-managed mutual funds and then sitting back. Meanwhile, an active form of passive investing is choosing how you wish to be invested and how much risk you wish to be exposed to, and then letting a professional handle the specifics.

But here’s the thing: Over the course of your investing life, you won’t always fall into the same category. As our lives evolve, our investing styles will evolve right along with it. In fact, the desire to actively control our portfolios will sometimes wane with age and experience, explains Andy Smith, executive director of financial planning at Edelman Financial Engines. This is because as we head towards a retirement date, our assets become more substantial, which means the stakes get higher and our money issues become more complex. So, people who were happy being in the driver’s seat for decades may now realize they need a little help. “People call and say, ‘Help me with this because I don’t want to do something that’s going to jam up my family. I’ve worked too hard for this. I’ve saved my entire life,’” Smith says. 

Timing Is Everything

There’s also the time factor to consider here. Smith says that if you trade your own stocks, ideally you should dedicate an hour a week per stock or 30 minutes per ETF to make sure your strategies and allocations are working. But this level of hands-on involvement just isn’t realistic for many people who have children to care for, increasing job responsibilities or otherwise full calendars. If you’re just too busy, don’t feel bad! Smith stresses that it’s not “better” or “worse” for someone to be a passive vs. active investor — they’re just different tools in the toolbox. 

No, You’re Not Smarter Than The Market… But You Might Be Smarter Than Institutional Investors 

Smith’s primary advice to active investors is simple: Don’t think you’re smarter than the market. “When you think that you can beat the market with hundreds of billions of dollars and huge investment teams, the market is ready to eat your lunch,” he says.

On the other side of the investment coin, as Jason Zweig recently wrote in the Wall Street Journal, individual investors often do better than institutional investors – and they have been lately. He writes: “most portfolio managers own too many stocks to focus on their best ideas—but not enough to maximize the odds of finding a giant winner… Individual investors, by contrast, can capture every needle in all the haystacks with a total-market index fund. Then you can add the potential for outperformance by trying to pick the next superstocks yourself.” In other words, don’t be fooled into thinking that a “professional investor” is always going to perform better than you will. 

Taking It Easy… 

For young investors who are just dipping their toes into the waters of investing — perhaps launching a retirement fund with a 401(k), Smith recommends looking to target date funds. “These allow people to focus on saving as much as they can for as long as they can,” he says. “You’re not having to pick one fund over another. You’re not having to allocate at the beginning. Your job is to plow as much money as humanly possible into your 401K. Let the target date fund do what it’s supposed to do.”

In other words, he says, “Diversification works.” 

And that’s perhaps the best advice we’ve heard for all investors — active, passive, passively active, or actively passive. Whew. 

MORE ON HERMONEY:

• How to Handle Sudden Stock Market Moves
• Market Volatility: Is It Time To Get Used To It?
• The Two Economies and Stock Market Investing Today

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