Active vs passive investing: Which is better?

What is active investing?

Active investing is a type of hands-on investment strategy. As an active investor, your main priority will be to beat the market or a specific index such as the S&P 500 or FTSE 100. To do this, you’ll need to research individual companies, analyse market trends and invest in assets you believe will outperform the market or indexes. This is where the “active” part comes from - you need to actively research what funds or companies you want to invest in. While it involves more research, active investing has the potential to generate higher returns than passive investing if you’re able to beat the market, but for this same reason it can involve more risk and higher fees. 

Another way to do active investing is to purchase actively managed funds within an investment account, such as a Stocks and Shares ISA, Stocks and Shares Lifetime ISA or general investment account (GIA). A fund manager will build and manage your portfolio for you, saving you time and potentially leading to better returns - but not always. Remember there is no guarantee that your investments will go up over time.

Make sure you compare management fees before selecting an account, as these can add up over time and impact your investment growth. You’ll also want to consider trading fees, as some platforms will charge you a small fee every time you buy or sell an investment. 

What is passive investing?

Passive investing is a less hands-on investment strategy than active investing. Instead of researching and selecting specific companies you want to invest in, passive investing usually involves investing in funds that track popular market indexes. Instead of trying to beat the market, your goal as a passive investor will simply be to match it. 

Passive investing can be a great way to build wealth over time without taking on too much risk. It can also be cheaper than active investing. You won’t need to trade as frequently, resulting in fewer transaction costs and in some cases lower management fees.

Passive investing is great for beginners, but even some of the most experienced investors are passive investors. They might not have time to keep up to date with changes in the stock market, choosing to sacrifice the possibility of greater rewards for more stable and predictable returns. 

Learn more: Where to invest: 4 ways to invest your money

What is an example of active and passive investing?

An example of active investing is opening a Stocks and Shares ISA and purchasing shares of individual companies within the money you place into that account. While an example of passive investing might involve opening an investment account and investing in funds that track a specific index. You could choose a mutual fund that tracks the FTSE 100, for example. Or you could choose an exchange-traded fund (ETF) that focuses on specific themes or industries such as healthcare, technology, or sustainability. 

As these funds aren’t actively managed, their holdings won’t change as frequently as those within an active fund. If a particular investment or group of investments are underperforming, this can affect the performance of the fund as a whole.

Learn more: What is an ESG fund and how to invest in them.

Is active investing more risky?

Active investing can be more risky, as you are relying on your own research, or that of a fund manager, to accurately identify companies whose growth will outperform the market. If you get it right, you could see greater returns than if you had used a passive investment strategy. But you could also not see any greater return, or even lose money. This is why active investing involves greater risks than passive investing.

Is active investing better than passive?

There are pros and cons to both active and passive investing. The best option for you depends on your personal situation and goals. If you’re new to investing, a passive approach lets you get started without needing lots of money, experience or time. You won’t need to research individual companies or understand the inner workings of the stock market. You could get started by investing in passive index funds, with as little as £1 depending on the platform you use.

As your knowledge and experience expand over time, you could experiment with more active investments. This might involve buying shares in individual companies you’re particularly passionate about, but you don’t have to do it alone. With actively managed funds, you’re relying on the fund manager’s expertise to boost your chances of beating the market, while also benefiting from some diversification. 

Can you do both active and passive investing?

Instead of choosing between active investing vs passive investing, you could make the best of both worlds. Passive investments can provide stability and protect you from market volatility, while active investments give you a small chance of beating the market and earning even greater returns. 

Remember, the value of your investments and the income from them can fall as well as rise and you might lose the original amount invested.

How to tell if a fund is active or passive?

If you are investing in a tracker fund or index fund - a.k.a one that tracks market indexes - you are passive investing, as the tracker will simply aim to replicate the performance of an index like the FTSE 100. Actively managed funds will have managers who try to select the best-performing investments on your behalf.

Is ETF active or passive?

An ETF (exchange-traded funds), can either be active or passive, depending on whether they track an index like the S&P 500, or are managed by a professional fund manager who makes the decision of what to invest in.