One of the longest lasting debates among investment investors is whether to invest in active or passive investment funds. There are plenty of arguments to suggest one is better or worse than the other, but deciding which is best for you will come down to your own investment preferences and what you are looking for in an investment. Of course, passive investments include index investment funds which typically come at a much lower cost (expense ratio) than active investments (such as an ABC Growth Fund or DEF Value Fund, etc.). One of the arguments is that these active investments are aiming to outperform the passive investments, meaning they will take on more risk than the index simply to achieve marginally better returns.
So which is best for you? If you are building your investment portfolio and are unsure which type of investment makes the most sense for your needs, start by asking these simple questions:
– Am I looking for someone to invest for me, or do I want to make the investments myself? Look at this as opposite forces: passive investments (index) require active management on your part, and active investments require occasional monitoring on your part. This means that if you invest in a series of indexes (a bond index for your fixed income asset class, a broad market for your domestic equity exposure, a Russell 2000 Index for your small cap exposure, an MSCI Emerging Markets for your emerging markets exposure, etc.) you will need to keep a fairly close eye on your overall asset mix. That will involve shaving excess gains from one index and investing it in a lesser-performing index in the other asset classes. An actively managed fund on the other hand will keep individual holdings from running out of control, not only reducing your risk but freeing up your time.
– Can I achieve the same type of management on my own? If you prefer index investing, make sure you investment objective can be met purely through passive investments. This means that if you want specific exposure to a specific industry, you may be stuck with the broader market or you may not be able to achieve as much aggression as you might want. Index investments are great for a more general investment approach (although there are so many indexes that you can probably find an investment that works well enough for your needs) whereas active investments can accurately tune into specific market niches.
– Am I satisfied with the track records? With an index investment, you will take whatever the index returns; with active investments you could win even when the index loses. This becomes something of a game requiring occasional reviewing on your part to make sure that the active management is still working the way it should and that the fund’s approach remains relevant to what your portfolio needs. That is not the case with an index investment where there is no portfolio theory — what you see is what you get.
The time demands on each will depend on what the market is doing and how the funds perform. Choosing one method exclusively could result in a lot more work, whereas choosing an index for familiar asset classes and active funds for unfamiliar asset classes might be a better strategy for novice investors. For most, however, it is one way or the other; decide your position carefully.