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Active vs. Passive Investments. What's the difference?

Active or passive investment strategies. What’s the difference. And importantly, what’s best?

In recent years substantial sums of investor capital have been invested in passive investment strategies and moved out of more traditional active strategies.

Passive investing, otherwise known as index investing, is a style of investing that mirrors an underlying market. For example, a particular investment could be purchased to replicate the performance of the Australian S&P/ASX 200 index. In theory, its performance should match that of the index, no more or no less.

Active investing involves an investor or asset manager attempting to use their skill to outperform the market.

One of the main attractions of index investing is its low cost nature. And the fact is, in recent years, many active fund managers have failed to outperform the benchmark, leaving investors to ponder, why bother paying additional fees for active management?

One of my main concerns with many passive index investments is that the strategy is based on market capitalisation (size) and price movement, not by changes in the value and quality of the underlying business. 

For example, if you buy an index fund that replicates the Australian S&P/ASX 200 index you are effectively buying a piece of the top 200 companies on the Australian sharemarket. The higher the share price rises of a company within this index, the more of that company you are “forced” to buy. You are essentially buying yesterday’s winners and hoping they become champions of tomorrow.

Conversely, if a stock falls in value the index fund would reduce this position to maintain its level within the index’ weighting. Or sell it altogether if it drops out of the index.

But investing isn’t always that simple. Markets move in cycles, up and down. Quite often yesterday’s winner is a company that you may want to reduce or sell, not add more to. And a quality business that falls in price may present an opportunity to top up. Index investing does not allow for this. It goes against the adage of buy low, sell high.

I am not saying that index investing doesn’t have a place for investors. If low cost investing is your number one objective and you have a long term investment view, with a sound asset allocation approach, there is no reason why this investment approach could not work.

But if choose a qualified and proven financial advisor, an active investment is always worth considering.

Of course, if your financial advisor or asset manager isn’t performing you would be best served exiting that from their investment strategy. The proof is in the pudding. If your financial advisor or active investment manager is not performing and justifying the additional cost, you would be unwise not to explore your options. You need to find the right financial advisor/asset manager to work with.

At Hewison Private Wealth we believe client outcomes should be the main priority. Investment decisions should be driven by client needs and tailored to individual circumstances and financial outcomes.

There is no point investing in the cheapest fund if it is not meeting your goals and objectives. We favour a direct investment approach and design a tailored asset allocation to assist our clients to meet their goals and objectives.  Our clients’ portfolios are adjusted or rebalanced as needed to remain in line with their specific asset allocation or to take advantage of market opportunities. 

A direct investment approach provides our clients with ultimate control over their investments. For example, owning an investment directly means you know exactly what level of income it pays. It that level of income changes, the decision is yours whether you remain invested or exit.

Hewison Private Wealth are independent financial advisors and investment experts. If you’d like to discuss your needs and financial objectives then contact a Hewison financial advisor on 03 8548 4800 or email info@hewison.com.au. Visit www.hewison.com.au for more information.

For other blogs and discussions on varying investment strategies see:

Please note: The information provided above is general information only and individuals should seek specialised advice from a qualified financial advisor. The views in this blog are those of the individual and may not represent the general opinion of the firm. Please contact Hewison Private Wealth for more information.