Active vs. Passive Investing: Which Method is Best For You?

This blog post originally appeared on Saagar Gupta’s website.

Additionally, this blog post does not contain investing advice in any form. If you are interested in the topics discussed throughout this article, please speak to your trusted financial planner and formulate a plan that works best for you.

In the financial sphere, professionals get into heated debates about nearly everything — whether or not you should invest in certain stocks, whether or not Bitcoin is a trustworthy investment vehicle, and whether or not the bull market is truly over. Therefore, it should come as no surprise that the timeline one sets for their investing efforts is a hot topic as well.

To some investors, their efforts are merely a game and the goal is to stay ahead of the market by trading stocks and shifting their focus at the drop of the hat — otherwise known as active investing.

For others, it is imperative to keep one’s emotions out of their investments. This is achieved by formulating — and sticking to — a well-developed and thought out plan, regardless of any dips in the market. This method is known as passive investing.

How can one determine which method is best for their financial situation and long-term goals, all without being influenced by the potential biases of their financial planners? The answer is simple: doing ample research on each method on their own.

With that in mind, let us take a closer look at active versus passive investing.

The Advantages and Disadvantages of Active Investing

Taking the active route provides one with more flexibility, as they are not locked into a specific index. Additionally, active investors are given the opportunity to hedge their bets when the risk becomes too high. This is accomplished through short sales, stock trading, and so on — whatever it takes to exit a sector or stock.

However, the game of staying ahead of the market is not always as successful as it may appear. In fact, it is proven to cost investors more over a shorter period of time. This is because one not only pays for the active buying, but for transaction fees and their analyst team’s salaries as well — hence why an active investor’s expense ratio is approximately 1.4 percent, while a passive investor’s expense ratio hovers around 0.6 percent.

Additionally, because of the high, non-transferable risk associated with active investing, one is constantly susceptible to losing everything.

The Advantages and Disadvantages of Passive Investing

As previously mentioned, the costs of passive investing are far lower than those of active investing. In addition, passive investments are far more transparent than their active counterparts, as sticking to one plan means it is always known which assets are in an index fund. By far, this is the safest option of the two.

However, the safety of passive investing is both a blessing and a curse, as it can seriously hinder one’s efforts to maximize their returns. This is because one must keep their emotions out of their investments and hold fast to a long-term plan — even in the midst of market downturns and other undesirable events. Because of this, passive investing typically generates smaller returns, but at a much lower risk.

In order to determine which method of investing is the better option for you, be sure to set clear, long-term goals and thoroughly discuss them with a trusted financial advisor.

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