Whether you’re investing for retirement income, to preserve family wealth, or to save for a large purchase down the line, there’s generally a consensus around a desired outcome for investment income. More is better. How you best get there, though, is subject of an ongoing debate: should I pursue a passive or active investment strategy?

For many, passive investing, such as in a company managed 401(k), is the default due to ease and low-maintenance. More involved or savvy investors may want more control or the performance potential that an active approach can offer. Ultimately, the best approach will likely include both strategies and how they’re weighted will be driven by your goals, risk appetite, aptitude, and personal preferences.

“How to choose an investment strategy is unique to each person and will be dependent on risk tolerance, but also simply the time and desire to influence trading decisions,” said Andy Schuler, Investment Management Director for PNC Private Bank. “Both strategies can be effective if you weigh their advantages against your personal goals.”

What’s the difference between active and passive investing?

Active investing is a strategy that relies on making decisions around the buying, selling or holding of assets based on market forces, with the goal of realizing gains by outperforming the overall market. Active investing strategies require research, careful review of the assets in a portfolio, and frequent trades in reaction to market activity.  An active investment strategy can be employed by the individual investor or with the help of a fund manager.

Key advantages of an active investment strategy include:

  • Ability to outperform the market – because the manager is actively trading individual stocks they are theoretically able to time the market for profitability;
  • Efficiency in responding to market swings – active trading allows for managers to react in real-time to the ups and downs of the market;
  • Potential for gains when the market is down – instead of absorbing losses during a bear market, there is potential for finding hidden winners; and
  • Flexibility to pick and choose individual stocks in a portfolio – active managers aren’t beholden to the stocks in a given fund.

Key disadvantages of an active investment strategy include:

  • Cost – because stocks are being actively traded, there will be more transaction fees on top of the cost of the professional fund manager;
  • Investment risk – consistently outperforming the market is a difficult science, which can lead to losses; and
  • Time commitment – actively managing investments is a time intensive process requiring research, analysis and active trading – especially if you’re managing it on your own.

A passive investing strategy is designed around the principle of buying and holding over the longer-term. Passive strategies do not rely on short-term reactions to market activity. Most often, passive investment management is achieved by investing in an index fund that tracks an index such as the S&P 500, Dow Jones, or a basket of stocks. The fund tracks the performance of that index and, over time, mirrors its growth and declines.

Key advantages of a passive investment strategy include:

  • Long-term reliability – Over time, history tells us that the market will grow. Investing in an index fund that tracks the market mirrors that growth;
  • Diversification – Investing in a fund with a variety of stocks provides a natural buffer to a downturn in any one industry;
  • Time efficiency – Because a passive strategy relies on buying and holding, research and tracking of individual stocks is unnecessary on a daily basis; and
  • Cost efficiency – That buy and hold strategy also means fewer trades, transaction costs and potential taxable events.

Key disadvantages of a passive investment strategy include:

  • Inability to beat the market – The safety of mirroring a reliable index means your gains are limited to the index’s growth. You won’t have the opportunity to capitalize on beating the market with individual trades;
  • Subject to market performance – Although history shows market growth over the long-term, passive investment strategies are also subject to the market’s downturns without the ability to shed individual underperformers; and  
  • Inability to pick and choose – If you’re investing in an index fund, you have less control over the individual stocks in the fund.

What’s right for you?

Common doctrine may say that a passive approach to investing is a safer way to realize reliable portfolio growth over time. Active investing requires consistent research, trading and timing to achieve growth at what can be a significant cost. Still, it can’t be ignored that a passive approach is not without investment risk from a down market, with little ability to control individual decisions that can both shield losses, or outperform an index. Passive approaches can also forfeit much of the benefit of a professional fund manager’s expertise.  

Ultimately, the answer to whether an active or passive investment strategy is right for you will depend on your individual investing goals, your time horizon in the market, and your risk tolerance. For many investors, the right approach will be a combination of investing in a passively managed fund, while devoting additional assets to a more high-risk, potential higher-reward active approach. Your advisor can help you map out the risks and advantages to each strategy relative to your unique situation.

“Properly managed, both methods, can be good investment strategy,” Schuler said. “You don’t necessarily need to choose between one or the other, but your advisor can help determine how you weight your assets between passive and active approaches.”