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Passive Investing vs. Active Investing: What’s the Difference?

Both passive and active investing have their pros and cons, and both can be an effective way to grow your investment portfolio, build wealth, and gain a secure financial future. Let’s take a look at what these two types of investment strategies mean and how they can help you make smart choices about your finances.

Key takeaways

  1. Passive investing is a hands-off strategy that generally involves investing in a conservative type of investment such as an ETF.
  2. Active investing, also called active trading, means buying and selling stocks on a regular basis, which is riskier but can also net bigger returns.

Passive investing and active investing: What are they?

You probably already have an idea of what passive and active investing mean based on their names alone. Still, we’ll break down the concepts and get into some detail below.

What is passive investing?

Passive investing is a long-term approach to building wealth. With a passive investment strategy, you take fewer risks in favor of more solid, tried-and-true investments, such as exchange traded funds (ETFs). An ETF is a type of security you can buy and sell on a stock exchange just as you would any other stock. They contain multiple assets, including stocks, bonds, and commodities like gold, which makes them similar to mutual funds.

What is active investing?

Active investing is a hands-on investment approach that calls for monitoring the stock market on a regular basis. With this investment strategy, you’ll be buying and selling with an investment portfolio that’s in regular flux. Active investing is associated with a higher level of risk.

You might also see active investing referred to as “active trading” because it typically involves someone “playing the stock market” and making regular trades as stocks fluctuate.

If you’re interested in active investing, there are a couple ways to get started. Some people like to work with a broker, who can help you with guidance. You can also take a more independent approach by using an investment app. The latter has become a popular option in recent years, as many people like the convenience of making trades on the go.

Passive investing vs. active investing: The pros and cons

One of the primary differences between passive investing and active investing are the returns—how much money you can generate with an investment—along with the level of risk involved.

Passive investing: The long game

Passive investing is generally viewed as a safer, more conservative way to invest. There’s less risk involved than with active investing (which you’ll see below), as you’re not making regular trades, which means you’re not vulnerable to unexpected market swings. On the other hand, some people claim there is less opportunity to make high returns.

Pros

  1. Very transparent investment strategy since you always know which assets are in your investment portfolio
  2. Less risk involved, which makes it a good strategy if you’re trying to build a retirement fund you can count on

Cons

  1. Less opportunity for high returns—it’s a slow and steady investment approach
  2. Somewhat limited, since funds are restricted to a specific type of investment, such as the pool of assets you see in an ETF.

Active investing: Big risks for big rewards

Generally, active investing is seen as a strategy that can net higher returns. Keep in mind, however, that there is an element of risk, as you can’t truly predict what the stock market will do. Many factors influence the stock market, and not all of them are foreseeable. For example, a company might get hit with a cyber attack that makes its stock prices plunge.

Pros

  1. Opportunity for higher returns
  2. More flexibility, since you can quickly jump on a trend if a stock is making gains
  3. Hedging, which means you can offset the risk in one stock by making a trade in another

Cons

  1. Possible capital gains tax implications if a stock sale triggers the tax
  2. Involves more risk, since making the wrong move could mean losing a lot of money if the stock market experiences a big swing or an individual stock loses money

Which investment strategy is right for you?

There’s no one-size-fits-all way to invest. In recent years, active trading has seen something of a boom, as trading apps have made trading accessible to anyone who wants to play the stock market. This has opened up trading to new generations of investors who grew up using the internet and are comfortable making financial transactions online.

While trading apps can be a great way to learn how to invest, passive investing can also play an important role in how you grow your wealth. A common strategy is to engage in more active investing when you’re young and have the ability to absorb more risk. Then, as you near retirement age, you can make the switch to a more passive investment strategy. Depending on your comfort levels and risk tolerance, there are numerous investment strategies available to you. However, the first step is to understand the personal factors involved in investing.

Learn more about investing in your future

Want to learn more about building wealth and securing your financial future? Whether you want to make active trades or grow your money through passive investments, Baraka can help you achieve your goals. We offer the resources you need to learn more about making your money work for you.