How Does Active vs. Passive Investing Affect Portfolio Returns?

Most people who think about investing for the first time usually think of the classic active accumulation of wealth. Active investing means investing money with the conscious or subconscious goal of exceeding the market return.

But more and more investors are now choosing more cost-effective passive investing for their investment strategy. No matter whether you invest passively or actively, each type of investment has different advantages and disadvantages, especially in terms of the risk-reward ratio.

Passive investing, as you understand and know it today, hasn’t been around that long. Investors who invested before this time did not have to ask themselves whether they were investing actively or passively – they automatically resorted to active investments.

Which type of investment suits you better depends on your type of investor. If you want as little effort as possible with less risk, passive investment options are more suitable for you.

If you have an individual investment goal and have been involved in the financial market for a while, you can also think about becoming an active investor.

What Is Active Investing And How Do Active Managers Select Investments?

When actively investing, investors try to optimize their investments so that they achieve a higher return than the market. The investor or a fund manager manages the investment themselves, for example by analyzing the international markets or speaking to analysts or companies. Anyone who wants to actively invest their money usually invests it in stocks, bonds, funds, or other securities. 

With active investing, fund managers or the investor themselves oversee the investment. They manage and optimize investments to achieve particularly high returns and outperform the market. 

Actively managed investment funds, on the other hand, deviate from the benchmark index to achieve a higher return over a certain period and after costs. This requires fund management that evaluates companies according to certain criteria. Companies or sectors with a positive assessment are given a higher weighting in the fund composition. 

Depending on the prevailing market environment, an actively managed fund can also control the risk profile. If the market environment deteriorates, the investment risk is reduced, and vice versa.

This is to outperform the benchmark index in positive markets and lose less return in negative markets. This creates additional return potential. This active service by the fund manager is compensated for through fund fees.

How Do Passive Investments Like Index Funds And ETFs Compare To Active?

Passive investing, on the other hand, means using the money for the long term and, for example, using it on the stock exchanges and profiting from the performance of the stock exchange or the market itself. In addition to stocks, this also works through savings plans or forms of (digital) asset management.

One aspect that investors particularly value about passive investments is the very low effort involved. Even with little time, resources, and financial knowledge, they can become market participants on the stock exchange or other markets. The decisive factor in passive investing is the investment strategy, which is primarily determined by buy-and-hold. 

As an investor, you don’t constantly buy new securities or sell them from the portfolio, but invest your capital over the long term – for example, for an investment period of 10 to 20 years. The best-known investment option in passive investing is the ETF.

However, digitalization and the development of the market have created additional alternative strategies with attractive return opportunities: digital real estate investments.

What Are The Costs, Fees, And Performance Considerations Of Active vs. Passive?

In our guide, I take a closer look at the question “Investing actively vs. passively?” and explain to you what options you have for the respective investments and what this has to do with your investment strategy.

Active fund managers want to beat the market return, while passive strategies, e.g. B. with ETFs, usually aim to reflect the development of an index. By passively managing index funds or other investment products, investors save costs, which in turn has a positive effect on returns.

Passive investing has become particularly popular through ETFs (Exchange Traded Funds). ETFs are exchange-traded index funds that reflect an index.

When it comes to the question of which form of investment is suitable for you, your expectations and fears play a role. Investors who are more willing to take risks usually value the high return potential of active investing, while investors who need security value lower-risk investment options.

Are There Blended Investment Approaches Combining Active And Passive Strategies?

There are also mixed investment models that combine active and passive investment models. Active investment classes such as stocks, bonds, funds, or other securities may be managed alongside passive investment classes such as ETFS. 

History has shown that passive investing can often beat active approaches in terms of returns. Only rarely can active fund management beat the market return, while passive investors can achieve more returns because, for example, they simply follow the indices.

In general, it is not possible to choose a winner when comparing “active vs. passive investing” because ultimately the appropriate choice of investment always depends on the personal wishes and expectations of the investor. Your risk tolerance also plays a significant role when choosing your type of investment.

If you shy away from risky investments, active investing will probably not be for you, while there are many lower-risk alternatives to passive investments that can still offer an attractive return.

How Does The Choice Between Active And Passive Investing Impact Taxes?

While more transactions in active investment models may lead to higher tax expenses, in passive investment models, since transactions such as asset transfers are carried out less frequently, tax expenses are not as decisive as in active investment models.

All profits that you earn from trading securities – regardless of whether you invest actively or passively – are subject to withholding tax. 

However, long-term passive investing offers one advantage: If you rely on an accumulating investment, you can use the deferment effect and save money. Because the tax is due later, the reinvested money can generate interest for longer.

See you in the next post,

Anil UZUN