Which is Better for You – Active or Passive Investing?

A passive armchair investor and an active day trader have two things in common. They both rely on making the right decision at the front end of their investment cycle; active decisions.

So the question begs: is there actually such a thing as passive investing?

In its simplest form a passive investment could be an index tracker. Passive, yes, because once you invest there is no further action required. You can go on holiday and forget about it. However, choosing the index is an active decision because you need to choose the right one.

In Net Worth of June 1 (“The Intricacies of Self-Managed Investing“), I looked at how in 2012 the Thailand stock index grew by 36% and the Philippines index by 49%, whereas the S&P 500 performed at a mere 15%. The following year Thailand dipped 9% and the Philippines 20% whilst the S&P grew 29%.

Many investors can look back and say that it was obvious that an investment in the Philippines was the right choice for 2012 and a change to the S&P 500 should have been made the following year. Hindsight is a wonderful thing and people will be swayed by it very easily. It also instils a false sense of confidence in the wrong people.

Once you have chosen your passive investment holding you have made an active decision. So what is the process of making such a choice? It is surely projections into the future based on the same reasoning which must be made for active investing decisions. Once chosen, you leave the holdings alone because they need to remain static as your passive investment.

Yes, there is a significant difference between these two types as we move forward. The active investment will need to be monitored on an ongoing basis and changes made when necessary, in “real time”. Whereas the passive holding will simply remain in place as is.

A point raised by one of my readers was that the major indices have outperformed any other recovery since the 2008 crash. If we take the low from early 2009 we can see that the S&P 500, the UK FTSE and the US Dow Jones have all made good recoveries from that low, of between 55% and 105%.

 

Chart - What is Best for You - Active or Passive Investing
The best performing mutual fund in the FTSE area made a 433% gain in the same period, which is more than eight times the actual FTSE index. This shows that active management can outperform passive management. However, this is just one actively managed fund and the best performer at that. There are other funds which have not managed to beat the index. Thus choosing any fund is an active investment decision.

Now we seem to have exposed that, as an investor, you can choose a passive index tracker or similar holding; a mutual fund which will actively manage on your behalf; or buy individual holdings which you can self-manage as you go along.

In all three choices you will need to make active decisions to choose the type of investment and then the actual holding. This is where the comment made last time becomes relevant in that the internet gives you information overload. By the time you have researched the type of holding you will use and drilled down to the sector and geography allocations to be made, you will be exhausted by the amount of work which needs to be undertaken.

At this point many will say that they will just choose a major index tracker and be done with it. Others will prefer to manage their investments themselves and accept the results they are able to attain. This will become a full time job and create personal stress to the investor. Still others will engage an adviser and then proceed to criticise the work which he undertakes using hindsight. There is no correct answer. There are simply consequences.

Something which really drives these essentials is your risk appetite and your combined time horizon for withdrawals from your investment.

In measuring these factors you will go a long way toward resolving what is actually best for you. In this respect you should come and see me so that I can help you assess your factors and attitudes on an objective basis. I will then devise a strategy for you and advise you what type of investment allocation and holdings will suit your attitude toward risk and dovetail this into your future requirements for withdrawals.

Perhaps a master stroke in resolving this entire issue is to invest 50% in active and 50% in passive holdings. But be careful; managing half your assets requires the same effort as managing them all. It is only the results which may be different. The only constant is change.

Questions to the author can be directed to PFS International on 02 653 1971 or email to enquiriesthailand@fsplatinum.com

Andrew Wood has been an expat in Asia for 34 years and is Executive Director with PFS International. He has been writing Net Worth articles for six years and has made a significant contribution to the PFS library of financial service articles dating back over nine years. These articles which cover the complete A-Z of financial planning are available to readers on request.

 

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