Active vs Passive Investing

The financial jargon across the web is a lot like sports talk. And if you aren’t a fan, can make you feel like a real outsider. But understanding the basics of investing isn’t too hard.

The purpose of investing is to have your savings grow over time so you have more money in the future — more money than if you stuffed it under your mattress, or left it in a savings account at the bank. With savings accounts currently paying a lot less interest than the cost of living is rising (inflation), your money may actually lose buying power by simply leaving it all in a bank account (and certainly under the mattress).

So investing in stocks and bonds, mutual funds or Exchange Traded Funds is what many people do to grow their savings over time.

One of the most important things to know about investing is that you really should have a strategy to be in this game.

Strategy A: “Active” investors who believe they can beat the market.
Some investors think they have the skill to pick the right investments and buy or sell them at the right time so they get great returns. These are called “active” investors because they’re generally quite involved in researching investment choices and buying or selling investments based on their outlook for the future. Their goal may be to beat the market: getting returns that are greater than the combined return of all the stocks and/or bonds traded around the world.

Strategy Z: “Passive” investors comfortable with market returns.
At the other end of the spectrum are investors who are happy getting market returns. These “passive” investors know that markets have delivered growth over time and believe that long-term growth will continue. They invest in a large number of stocks and bonds — often by using index mutual funds and/or Exchange Traded Funds that represents the global market. In place of active research and frequent buying and selling to make profits, the passive investor’s tools are patience, a time horizon measured in years, not weeks, and a balanced portfolio they understand.

There are a lot of approaches between A and Z, but understanding these very different approaches is a good way to start building your own investment strategy. Do you think you can beat the market?

Passive investors see the markets as efficient — meaning the price of any stock or bond properly reflects its value. If that’s true, consistently beating the market is not possible. There are hundreds of thousands of investors around the world, many of whom are professionals and large institutions like pension funds and mutual fund companies, and information is instantly available to all.

Over time, accessing the long term growth of global markets has rewarded the patient investor, leaving them with time to pursue hobbies that don’t involve risking their life’s savings.

For a fun video to help you learn more about this, check out this TEDEd production from Visual Capitalist.