Investors often use two types of investment management in portfolio valuation: active and passive management. Both approaches have their benefits and drawbacks, and deciding which approach to use can be a challenge for investors.
This article explores the differences between active and passive investment management and offers insights into which approach might best fit you.
Active management is when you hire investment managers skilled in making investment decisions to achieve a higher return. Active managers attempt to beat the market by analyzing market trends, company financial information, and economic indicators. This approach can be more expensive than passive management because of the increased amount of research required.
The most significant benefit of active management is the potential for higher returns, but it can also come with additional risks. The risks come from picking the wrong investments or simply underperforming the market. Picking the right investments can be difficult if you don't have the expertise or knowledge of the market, so be sure to choose a reputable and experienced investment manager.
Passive management is a low-cost, hands-off approach to portfolio management. Instead of selecting individual stocks and bonds, you invest in index funds that track the market. This approach is much less risky than active management because you're not trying to beat the market, so you don't have to worry about making the wrong decisions.
The goal of passive management is to match market returns. This approach can be beneficial if you don't have the time or knowledge to actively invest in individual stocks and bonds. It also requires less research and due diligence, so it can be a good option for those who want an easy and hands-off investment strategy.
The drawbacks of passive management are the potential for limited returns and missed investment opportunities. Passive management can be less effective when market indexes decline sharply in bear markets. In this case, the index funds and ETFs will also decline, potentially leading to losses in your portfolio.
Additionally, this approach does not account for specific market opportunities that active management seeks to capitalize on. So, passive management may not be the best fit if you're looking for potential above-market returns or want to exploit certain market opportunities.
Which Approach Is Better for You?
The answer to this question is personal and varies from investor to investor. Active management may be the best fit for investors who want to achieve higher returns, have a higher tolerance for risk, and are willing to pay higher fees. On the other hand, passive management may be best for those who want to save on fees, prefer a hands-off approach to investing, or have limited capital to invest.
Another consideration when deciding which approach is better is your investment objective. Passive management may be a good strategy if your objective is to preserve capital because it allows you to match market returns, not try to beat the market. Active management may be a better choice when the investor has a longer-term objective, such as retirement savings.
For more information on portfolio valuations, contact a professional near you.