Active vs. Passive Asset Management—What’s the Difference?
Asset management strategies are vital for the effective budgeting and management of financial assets. Active and passive asset management follow contrasting ideologies. Choosing the right one is critical to ensuring capital preservation and a high ROI.
But, before choosing strategies, it’s crucial to understand how active and passive asset management strategies work and how they differ. Read on to learn more about active and passive asset management.
Understanding Active Asset Management and Passive Asset Management
Although active management of assets has a higher possibility of earning higher returns faster, it is often more volatile than passive management. As the name suggests, it is a proactive approach where investment assets are bought for their balance sheets and revenue growth. The investor studies the market situation continuously and then buys or sells assets accordingly. Investors leverage the market conditions to make effective gains. It takes an in-depth understanding of the market conditions and portfolios and is not recommended for beginners and new investors.
This is why individual investors often hire professional investment advisors and fund managers. In fact, research shows that working with an advisor could result in around 3% additional net annual gains for the investor. These professionals can help you make the correct buy, sell, or hold decisions, as well as, implement them for you. Investors may gain better returns than the benchmark rate when active asset management strategies are implemented correctly.
Passive asset management is almost the opposite of active asset management. This type of strategy is implemented by utilizing exchange-traded funds and mutual funds that are built to replicate the index. You are NOT able to invest in an index. You are only able to invest in strategies that replicate the index. This approach is also called index fund management. There is no continuous buying or selling of investment assets.
Passive investments basically replicate the investment holdings of a specific index and aim to achieve similar gains. Every stock listed as an investment is weighted in an attempt to match the performance of the index.
Active Vs. Passive Asset Management Strategies
Active and passive asset management strategies are different and the choice between the two should be based on investor preferences, market conditions, the investor’s current life stage, and the kind of investments that form part of the portfolio. Here are some key points to consider when comparing active and passive asset management strategies.
Cost of Employing Active vs. Passive Strategies
The cost of employing an active asset management strategy is certainly higher than the cost of employing a passive asset management strategy. Active investment management strategies demand comprehensive market studies, a view of the global economy, and quick decision-making. Active investing also involves higher research-related costs.
Although it has a higher cost, having an active management strategy is key to the preservation of wealth across generations.
The biggest risk related to passive investments is that the chances of earning “above-market” returns do not exist. Investors have limited capacity to take advantage of market conditions and react to market conditions. Additionally, the value shifts of underlying investments are not prioritized. An investor who implements a passive strategy will experience 100% of both the ups and downs of the index.
Active, like Passive, portfolio management involves risk. Active risk is the risk of not matching the returns of the benchmark investments. Investment markets can end up being severely tricky; even experienced fund managers can face uncertainty and unpredictability from time to time.
Changes in economic and political conditions can have a tremendous impact on investment market conditions. Thus, the risk of sustaining a near-term loss on investments is much higher. For this reason, individual investors often employ investment advisors and managers, like Fulcrum Wealth Advisors, to devise an approach to active management that protects purchasing power and maximize returns as is prudent to your wealth management goals.
Flexibility and Hedging Portfolios
Passive management tends to be more of a buy-and-hold methodology, and hedging is not utilized.
How to Choose Between Active and Passive Asset Management Options
There are several factors to be considered when choosing between the two asset management strategies. Your investment goals, style, current portfolio performance, present market conditions, and costs are vital points to consider.
For instance, if market conditions are unpredictable (as it was during the pandemic and during times of political unrest) it may be best to stick to decreasing the actively-managed portion. However, when market situations are favorable, it may be wise to decrease the actively-managed assets. A good portfolio has a healthy mix of both active and passive assets.
A diverse portfolio customized per your needs can help you attain the optimal level of risk and returns.
At Fulcrum Wealth Advisors, our goal is to protect your portfolio and help you maximize your returns. We prepare customized strategies to manage your investment based on the specific financial planning issues for you and your family.
Our financial and investment advisors employ their exceptional research skills and use a value-based approach to help clients through their wealth management journey. Visit our website or call (877)- 400 0260 to learn more.