Understanding Active Investing vs Passive Investing in Australia

Some investors want capital appreciation and income, while others seek to preserve capital. As an investor, deciding on active investing versus passive investing is one of the initial and crucial decisions to make in your investment objectives.

Active investing generally requires more time and effort than passive investing, as investors must continuously monitor the market and their investments. On the other hand, passive investing requires less time and effort, as investors can simply purchase index funds or ETFs that track a particular market or index. It is important to note that there is no guarantee that either active or passive investing will outperform the other in the long run.

This article takes a closer look at the two investment approaches, their similarities and differences.

How Does Active Investing Work?

Active fund managers engage in the process of buying and selling shares to generate profits for their investors. They will purchase shares anticipated to do better than the average market, unload shares that have recently done well, and bypass those expected to underperform.

The managers of an active fund actively research the companies that make up the index to find those likely to outperform the market average. These managers have access to professional resources, information and investment processes, making informed decisions about companies to invest in. The perception is that this gives them an advantage over individual investors who do not have access to these resources.

The goal of an actively managed fund is to outperform a specific benchmark index. The fund manager picks shares they believe will do well, and the hope is that the combined portfolio of these shares will do better than the index. However, there is always the risk that the shares will not perform as well as the manager anticipates, and in this case, the fund will underperform the index.

Active managers are usually judged by their performance compared to a benchmark index. If they can outperform the index by a significant margin, it’s generally seen as a sign of a successful fund. To select an active manager, investors need confidence in the manager’s ability to achieve their investment objectives. Most investors will consider a manager’s long-term performance track record before investing. The cost of actively managed funds is typically higher than for passive funds because of the research costs and the larger teams of experienced analysts employed in managing the fund.

How Does Passive Investing Work?

A passive investment manager tries to own the same shares in a specific market index, such as the ASX 300. The manager invests in each share proportionally as its weight in the index. For example, if BHP Billiton makes up 8.6% of the ASX 300, the manager will put 8.6% of the fund’s assets into BHP Billiton shares. The manager does this for every share in the index. The goal is to make money at about the same rate as the market index.

Passive investing is often compared to buying an index fund. An index fund is a managed fund that owns the same shares as a specific market index. The main advantage of passive investing is that it’s typically lower cost when compared to active investing. Passive managers don’t have to spend time and money researching shares, so they can keep their investment of time and fees low. Theoretically, this means that more of your money stays in your investment, leading to better returns over time.

The main disadvantage of passive investing is that it doesn’t offer the potential for outperformance. If the market goes up, your investment will go up, but if the market goes down, your investment will go down.

Choosing the Right Fund for You

When it comes to making those all-important decisions on where to invest, there are several key factors to take into consideration. These include tax implications, your risk tolerance and diversification. Investing is a powerful wealth creation tool. A considered and well researched strategy can give you the financial means to have options in your life and choose your own path.

Our expert team of advisers have adopted a centralised Investment Philosophy focused on the principles of evidence-based investing rather than active or passive investing. Evidence-based investing is an investment approach based on scientific financial research – it considers the long-term observation of markets and how they work. Using our Investment Philosophy, our Senior Advice Team scoured the markets to identify world-class investments and competitive account solutions that are used as standard best-practice in our business.

Newcastle Financial Planning Group is your go-to for trusted financial advice in Newcastle and Hunter. Because everyone is different, our team of specialist financial advisers takes time to tailor our advice to our clients’ individual lives and goals. Our team is passionate about delivering the best possible outcome for you based on your needs. If you need an investment adviser, we’ve got you covered! Call us or book online to secure your first appointment with us today and learn how we can work together to achieve your financial freedom!