Active vs passive investing

When it comes to investing, there are two types - active and passive.

Active investing is when you are hands on, making frequent changes to your investments to generate a profit. The perfect example of this is a stock broker, buying shares low and selling high, making a profit along the way. Another example is a house flipper, buying a run down property and flipping it for a profit. Active means hands on.

Passive is the opposite. Passive is when you buy a share, put the dividends on the Dividend Reinvestment Plan and never really think about the investment again.

Along the way, the share price goes up and down, but you’re not phased, because you’re busy living your life. You wake up one day 20 years later and find your investment has quadrupled in value.

All you had to do was make the initial investment, fill out the DRP consent and never worry about the investment again.

Now don’t get me wrong, active investing can be a lot of fun. And it can be profitable. It is exciting looking for opportunities, especially when they pay off.

It’s much cooler to brag about at the next BBQ “yeah mate I bought the share when it was 10cents per share, now it’s worth $2 per share. To the moon!”

What I sound like at the BBQ “I put my money into an index fund and it provides the overall market return while minimising fees”.

Yeah….so talking about index investing doesn’t quite have the excitement that comes with fast profits.

Remember this, most people will happily talk about their winners, but will never mention their losses.

I know plenty of people that call me to brag when their investments are going up…but I never hear from them when they are going down. That’s human nature unfortunately.

So while active investing has its appeal, it’s important to moderate the excitement with some realities:

• Constantly buying and selling increases costs, whether they be brokerage costs, Capital Gains Tax or tax administration costs. As we know, these costs eat into your overall return, reducing your net wealth over time.
  

• Active investing takes considerably more time than passive investing. That energy can be put into other things, like earning more, growing a side hustle, or more important things like time with your family.
  

• History shows us that ultimately, the majority of people (even investment professionals), fail to outperform the index over the long term.

Can you make money by active investing? Of course you can.

And potentially, if you take the time to become educated and experienced, you can make significantly more than the average stock market return.

But as superior results are not guaranteed from this strategy, an alternative approach is to move your ego to the side and accept the returns of the market via an index fund.

When most fund managers can’t outperform the market by selecting individual stocks, what chance do the rest of us have?

If we accept this reality and invest in index funds for the long-term, we receive the market return and reduce the fees along the way.

The irony is, by following this investment strategy, history shows us that we ultimately end up with a higher net worth and better investment returns.