Active vs Passive Investing: Which One Is For You?
People have been debating the relative merits of active vs passive investing for years and years. But over the last decade or so, investors have been trending towards passive investing in the form of index funds and cost averaging strategies.
But what is active or passive investing anyway? And why does it matter to you, the newbie investor?
It matters because if you’re going to start investing, you’re going to need to know the approaches that are available to you, and which ones suit your knowledge of the market and your financial goals.
To help determine the investment approach for you, we sought the advice of Fitz Villafuerte, a renowned financial planner and author of the book The Ready to Be Rich Guide to Investing. He also runs the Ready to Be Rich blog, which has been giving personal finance advice since 2007. Read on to find out his responses to how you can choose the right investment approach, and which investment products would be the best for beginning investors:
What is the difference between active vs passive investing?
FV: Active investing involves timing the market. You buy when prices are low, and sell when prices are high. Meanwhile, passive investing is simply putting your money in the market regardless of its prices. This type of investing is best associated with the cost averaging strategy.
Is there a trend towards either active or passive investing in the Philippines? And how do you see these trends developing in the future?
FV: It’s hard to tell where the trend is going. What I notice is that when the market is up, a lot of people are going for active investing. And when the market is down, then more people are doing passive investing.
Since the market has been on a bull run (a rising trend), a lot of people are attracted to trading and active investing. But all that can and will suddenly change when our market goes sideways or down.
The pattern I see is that when the market is up, new investors come in and most of them will become active investors or traders. But once the market corrects, those doing active investing shifts to passive investing. And when the market starts to go up again, those doing passive investing, after having learned from the past, will take out only a portion of their portfolio for active investing and continue with passive strategies. Meanwhile, the new bull market will then attract new investors who will go into active investing.
How can a new investor decide on the right investment approach?
FV: It’s always best for new investors to start with passive investing because it’s easier and more convenient to do. While he is doing this, he can now learn about the market, how it fluctuates and improve his understanding about investments. Once he is more knowledgable and skilled, he can now move a portion of his portfolio for active investing.
What are some passive investment products to get started with?
FV: Any pooled fund and growth stock would be a good candidate for cost averaging. Particularly, equity and growth funds perform very well if you do cost averaging on them for many years.
iMoney adds: If you don’t want to take the time to actively study the market and pick stocks, you can start investing passively with these products:
- Unit investment trust funds. These are pooled funds managed by professionals, and they’re a mix of passive and active investing — passive, because you’re not trying to beat the market yourself, and active because a fund manager is investing the money according to the governing rules of the fund. For more on this, check out our list of Philippine UITFs you can participate in for just P10,000.
- Exchange traded funds. These are like a combination of stocks and mutual funds. You can buy and sell them like regular stocks, but they’re made up of other stocks that aim to track the performance of the market.
The bottom line
Fitz Villafuerte advises: “For new investors, always go for passive investing first.” So if you’re thinking of starting to invest, use this method first and put your money in passive investment products or cost-averaging growth stocks. Then, when you become more confident and gain more knowledge, you can start moving some of your portfolio towards active investing.
Additionally, passive investing via pooled funds has the following advantages:
- Lower fees. Actively managed funds charge larger fees to pay for the fund manager and the research needed to outperform the index. “Many index-style mutual funds and exchange-traded funds charge less than 0.2%, some less than 0.1%, giving them a huge cost advantage,” says a report from Wharton School of the University of Pennsylvania, one of the top business schools in the US.
- Better long-term performance than active investing. The same report from Wharton shows that over a 10-year period, active mutual fund managers consistently under performed when compared to passive funds. “It’s just too hard for an asset manager to pick a portfolio that outperforms the market by enough to make up for the 1, 2, or 3% fee that must be charged to support the stock and bond picking operation.”
Hopefully Fitz Villafuerte’s answers on active versus passive investing have given you more insight on why passive investing is the best way to get started in the investment world.
But now you’re probably asking, “what’s that peso cost averaging that was mentioned earlier?” We’ll tell you all about it in the next few weeks, and how it’s the easy way to start investing. Stay tuned to our investment tag to learn more!