The biggest advantage of active investing is that it gives investors the freedom to analyse and assess the market and the power to make instantaneous buy-and-sell decisions in order to profit from short-term price fluctuations.
Actively managed funds also offer a greater degree of flexibility than passively managed funds. Active investors are well positioned to capitalise on market trends by buying potential high-growth stocks, selling particular stocks that become too risky due to prevailing market conditions, and investing in specific stocks that will help mitigate losses during downturns. Active managers can also employ various investing tricks and techniques such as short-selling and put options.
Needless to say, this hands-on stock picking approach is more time-consuming and requires a lot more knowledge, research, and effort than passive investing does. Perhaps this is one of the reasons why passive investment strategies have grown in popularity among investors in recent years, with nearly US$500 billion of new investment flowing into passive funds in the first half of this year alone, according to Bloomberg.
Index funds are huge favourites among passive investors as they offer the opportunity to invest in a wide selection of stocks without having to purchase them individually. The Straits Times Index, for example, is a blue chip index made up of the top 30 companies listed in the Singapore Stock Exchange (SGX). Index funds are designed to match or track a particular benchmark index, enabling investors to easily build a low-cost, diversified portfolio that basically replicates market returns over the long haul.
Exchange-traded funds (ETFs), a subset of index funds, are another popular passive investment choice. Basically, ETFs are funds that comprise a basket of securities listed and traded on the stock exchange, giving investors exposure to an entire market or market segment. ETFs offer trading flexibility as well as low management and transaction costs.
It is important to note, however, that although investors in index funds and ETFs can reduce the risks that arise from being overly exposed to a particular stock, these funds are not principal-guaranteed, and are susceptible to market fluctuations just like actively managed funds. Additionally, as their core holdings track the movement of a particular benchmark index, passive investors will seldom outperform the market and earn massive returns unless the market itself booms.