What type of investor are you? How you answer that question and the types of investments you choose should be based on your goals and objectives.
There are two basic types of investment strategy – active and passive. Both have benefits, value and serve different purposes. Which one is right for you ultimately will depend on what you are trying to achieve.
“Recently we have seen a lot assets move to passive structures and Exchange Traded Funds,” says Kathrin Forrest, portfolio manager with Sun Life Global Investments. “The objective of the typical investor is to save and grow their money for a house, retirement, their children’s education or some other purpose but both passive and active strategies can serve a purpose, have value and be the right option in different situations. It all depends on what you are trying to achieve.”
Passive investors generally invest for the long term. Passive investments limit the amount of buying and selling that takes, generally making them cost effective. The strategy requires a buy-and-hold mentality that resists the temptation to react to market and economic volatilities or anticipate the stock markets’ next moves.
A prime example would be to buy an index fund that follows one of the major indices like the S&P 500 or the Dow Jones. In buying into an index you are buying tiny pieces of hundreds or even thousands of stocks. Returns are made as the individual stock prices rise over time. Successful passive investors keep their eye on the big picture and ignore the short-term setbacks and/or sharp downturns.
However active investing, as the name suggests, involves a more hands-on approach and requires someone to act as a portfolio manager. The goal is to beat the market’s average returns and take advantage of short-term price fluctuations. In general it requires more detailed knowledge and expertise to know when to buy and sell particular stocks, bonds or other investments and involves a team of people who will research markets and investments and make recommendations.
Each investing strategy has its own benefits and drawbacks.
Passive investing usually has lower costs and fees and less risk but may have smaller returns than the active approach. Proponents of active investing might say that passive strategies are limited by being tied to a specific index and get smaller returns because their core holdings are locked in to track the market and passive funds rarely beat the market.
Active investors want to beat the market and can use varying techniques such as short selling or put options to generate higher returns. The returns may be higher, but so is the level of risk.
One of the big debates concerning the two different approaches revolves around costs.
Active portfolios generally will have higher costs and fees. Buying and selling triggers transaction costs and fees to cover the salaries of the portfolio’s manager and analysts who research investments and markets.
Passive strategies aren’t free however, and may involve some transaction costs as well as management and trailer fees.
Over the course of a lifetime there probably is a place and time for both types of investment strategies.
“There is value in both,” Forrest says. “Both serve a purpose and both can be used within a portfolio. Investors should be open minded to the full set of options available to them and choose those which will help them achieve their objectives. It all comes down to what you want to achieve.”
Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors.