Should You Actively or Passively Manage Your Money?

• Author: Jeffrey Simmons
• Posted: 2024-08-16

When it comes to an investing strategy for their own portfolio, people must choose between active management and passive management. The two involve completely different ways of managing your money. Here are some things to consider when you are making the choice since each one has its pros and cons.

Active Management Takes More Work

People end up spending a lot of time on managing their own money. While it may not be a full-time job, it ends up taking over their life as investing can become an obsession. In order to be a successful active investor, you need to do your homework and research. Not only that, but you also need to stay on top of market developments every day. You may find that this takes a significant amount of time out of your day, and it can cause you stress. This can also distract you from the other things that you need to do in your life.

Passive Management Is Easier

Many people complain about how hard it is to manage their own money. This keeps them awake at night because they are not as financially literate as they would like. With passive management, you do not need to know much about how the market works. All you would need to know is the benchmark that you want to match. After that, everything is as simple as buying an ETF or a fund and holding on to it. You do not need to learn or study or even spend any time figuring out your investment strategy. After all, there is a reason why they call it passive.

Passive Management Is Cheaper

This is less of a problem since many brokers have cut commissions, but active management still costs money. This is even more true if you are hiring a financial advisor to help you manage your money. With passive investing, all you need to do is buy and hold an index fund. It can be completely free, and you will never have to pay to manage your own money.

Active Management Allows You to Time the Market

Market timing allows you to add at least several percentage points on to your market returns by picking the right entry and exit points for your trades. By buying after the market has dropped and trimming your positions after a rally, you can outperform the market. You cannot do this with passive investing because you are doing nothing more than track an index. With active management, you can shift back and forth between stocks, bonds and cash to take advantage of and profit from market movement. However, not every individual investor is a good market timer. Some people actually cost themselves money by being too clever for their own good. However, those who can time the market will find themselves making money.

Active Management Can Lead to Mistakes

When you actively manage your money, you can be prone to making emotional decisions. You may even stop becoming an investor and start engaging in speculation. The truth is that you do not always know the right move when you are making your own investment decisions. Even a mistake or two can set your financial plan back years. Sometimes, it is better to just let the market work as it may and take yourself out of the way. After all, nobody ever had any regrets who just bought an S&P Index fund and watched the market on average go up each year. There are no investment decisions that you will lose sleep over later on in life. You do not have to worry about buying the next stock market debacle because you are not investing in individual stocks at all.

Passive Management Misses Out on Sector Rotations

One of the ways that you can outperform the market is by rotating in and out of certain sectors to take advantage of movement. For example, during the COVID-19 crisis, technology has far outperformed banking and energy stocks. If you had changed your portfolio weighting, you would have made some money. Then, you could lighten your tech exposure when the market seemingly hits its top. In passive investing, you are tied solely to a market index, and your portfolio largely does not change. You will achieve average returns, but you cannot outperform the market. In other words, your upside is limited with passive investing.