What’s The Difference Between Passive And Active Management?
With the ultimate goal of achieving high returns, investors choose between active portfolio management and passive portfolio management. While these terms may sound unfamiliar to you, they are broad concepts that are easy to understand. So what is the difference between passive and active management? Both active management and passive management are different approaches to how investors, account managers, and individuals make use of the investments in their individual portfolio.
Strategically speaking, passive and active management can achieve specific goals for investors. For example, active management helps to facilitate the goal of outperforming the market in contrast to previous degrees of performance. While passive management encompasses the goal of mimicking “the investment holdings of a particular index.”
Newly minted investors often struggle with understanding the importance and difference between passive and active management, but more importantly, are concerned with how the strategies of each potentially impact their investment success.
Read on below to learn more about the key differences between active management and passive management.
Active Management Versus Passive Management Differences
Investors who make a move to implement an active management approach typically use fund managers or brokers for the buying and selling of stocks, with the ultimate goal of outperforming prior market benchmarks or specific indexes like the Standard & Poor 500 index.
Investment funds that are driven by an active management approach include a team of individuals such as a portfolio manager and the various co-managers involved in the decision-making process for the fund and its future.
Funds that are actively managed hinge upon the successful combination of accurate market forecasting, extensive research, and the degree of expertise held by the portfolio manager and the co-managers of the fund.
Portfolio managers of active attempt to identify proper times to buy and sell positions in their portfolios under the premise that they can forecast the markets. Their expertise comes from an attentive focus on the rises and falls exhibited in the market, as well as keeping abreast of political happenings and the ongoing contemporary factors that have the potential to greatly impact global companies and more.
The knowledge and expertise of a portfolio manager are used in conjunction with market data in an attempt to invest strategically at the right time and place to achieve optimal results.
Passive portfolio management stands in stark contrast to active portfolio management. Often referred to as index fund management, it is, as the name implies; a more passive approach to investing. It does not involve the heavy reliance of outperforming a specific index or past market benchmark like the more aggressive approach found in active management. It simply attempts to mimic the performance of an externally specified index by buying an index fund. When managers align their investments with specific indexes, it allows for good diversification and potentially lower turnover.
Passive management might not involve a team of key players collectively strategizing to outperform previous benchmarks and making group decisions. Instead, passive management portfolios are often headed by a single manager and are typically formed as unit investment trusts or mutual funds referred to as exchange-traded funds.
An easy way to remember the main difference between passive and active management is knowing that passive management’s goal is to match successful indexes, while active management strives to outperform an indexes previous results with hopes of seeing a major gain.
Key Points and Examples of Passive Portfolio Management
- The passive management approach does not require a great deal of market expertise and industry knowledge because managers are not required to rely on their level of knowledge to strategize towards a result that excels to the point of outperforming previous benchmarks
- Managers of passive portfolios shy away from high risk investing and do not employ a proactive approach geared towards achieving phenomenal results
- Due to their passive nature, management fees for passive portfolio management are significantly lower than the fees involved with actively managed funds. Historically speaking, passively manage funds have generally outperformed actively managed funds.
There are a plethora of passive Income investment opportunities available today. Among the most popular tend to be the following:
- Real Estate
- Peer-to-Peer Lending
- Dividend Stocks
- Index Funds
Making the Decision Between Passive or Active Management
A truly personal decision, making a choice between these two investment strategies is largely dependent on whether you believe one can forecast and time markets, as well as your willingness to pay the significantly higher fees involved if you opt for active management.
Many investors opt for a diversified portfolio consisting of both active and passive management strategies to achieve a sense of balance regarding risk and cost.
Regardless of the approach you decide to take; active management, passive management, or a combination of both, always make it a point to remember that past performance is not always an indicator of future success and a strong outcome.
Danny G. Michael is the founder and CEO of Satori Wealth Management, Inc. He has 20 years of experience in retirement planning working with individuals, families, and business owners.