Most investing strategies are split into two broad categories: active and passive investing. Do you understand how these two investment strategies impact your goals? Here’s an explanation of active and passive investing, including what you need to know to leverage these two types of investments.
Active vs. Passive Investing: What’s the Difference?
Active and passive management are two broad investing strategies portfolio managers use in an exchange-traded fund (ETF) or mutual fund.
One goal of active investing is to pick out high-potential opportunities to attempt to beat the average market return. Another example of an active strategy is to manage risk to protect capital during market declines. Active investing is more tactical and strategic trades with the hopes of increasing investor returns over both the short and long term, respectively. For instance, with an active ETF—such as the Emles Alpha Opportunities ETF—a portfolio manager will strategically pick stocks they expect will experience positive action in the short or medium term.
Alternatively, passive investing focuses on pulling together a basket of stocks or assets that will hopefully produce steady, long-term gains linked to a common theme. Passive ETFs may be in step with a broader market index, or they can track a custom index that follows a unique specialty area. For instance, the Emles Made in America ETF (AMER) corresponds with the Emles American Manufacturing Index, which includes equities that are headquartered and produce goods in the United States. So, you may decide to invest in the AMER ETF if you think U.S. companies linked to production will gain alongside or above the broader market.
What Are the Pros and Cons of Active vs. Passive Investing?
Active versus passive investing strategies carry different advantages and risks. For instance, if you invest in an active ETF, that ETF’s portfolio manager will be able to respond to market trends as they happen or as they believe they will unroll. Alternatively, the fund may take a contrarian stance on what is trending in the market. For example, if the market is moving away from a particular sector for a short-term crisis, an active manager could take this opportunity to purchase stocks at a discount. If a stock becomes overvalued, an active manager may sell the security to lock in the returns and decrease the downside risk. However, timing the market and predicting where investors will go can be tricky and increase an investor’s portfolio risk.
Passive ETFs have different pros and cons. Because the goal is to follow the fund’s index, returns will mirror the market or sector of the fund models. This type of investing removes the challenges of timing the market and should rise and fall in tandem with the market or sector it tracks. However, because it will hold the underlying securities even when they sell off, it may also stand to gain when the market or sector bounces - gains that can be missed when fearful investors don’t see a rebound coming and sell their securities prematurely.
How to benefit the most from Active and Passive Investing?
We believe it’s a good idea to allocate a portion of your portfolio to active ETFs and diversify your investments with more passive ETFs or other passive investments. You may also wish to use a “barbell” approach by using some low-cost passive ETFs to give some balance on the edges.
Tips for Active Investing
Active ETFs are an accessible way to unlock the expertise of an ETF fund manager. Because of the ETF’s structure and tax transparency, investors can now benefit from advanced investing approaches that used to only be available to the ultra-wealthy hedge fund or institutional investor.
Tips for Passive Investing
Passive ETFs are generally the least expensive way to access markets and make it easier to diversify your investments. Investing in a variety of passive ETFs can help protect your funds against sector-wide or market-wide crashes.
Build the Best Investing Strategy for You
We believe investing between several passive ETFs, across different asset classes, and mixing in active ETFs is key to creating a well-diversified portfolio positioned for long-term growth. It’s also important to stay informed. The more you understand about the market and investing, the easier it will be to make smart investing decisions.
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