Active and Passive Investing - Assignment Example

TIVЕ VS РАSSIVЕ INVЕSTING Name of Student Institution affiliation АСTIVЕ VS РАSSIVЕ INVЕSTING 1. Define active and passive investing There are two main investment strategies which investors embrace that help them generate returns ; they include passive and active investment strategies. In this case, the passive investment strategy entails mimicking particular index investment holdings where as the active investment strategy it entails outperforming the market as per a specific benchmark. Active investing can be defined as investment which is dependable on the skill of a particular fund manager or investor to perform beyond the limits put or stipulated by a particular benchmark (Flood, & Ramachandran, 2013). The benchmarks in this case are indexes which are well known such as the share price index of Dow Jones in the United States market or the DAX share price index in Germany market. Moreover, passive investing is an investment strategy that is built on the general believe that it is close to impossible for one to out-think the marker let alone outperform it. Therefore, this investment strategy is basically concentrated on matching the market’s performance or the chosen sector of the market as a whole (Trudeau, 2014). In this investment strategy this is made possible through closely tracking or following a particular investment index for instance the FTSE 100 index associated with the biggest companies in United Kingdom (Fraser-Sampson, n.d.). This paper therefore aims to review the difference between active and passive investing. 2. Evidence for active investing (against passive investing) Active investment is more ideal compared to passive investing because it focuses on active bond funds and active equity funds. This shows that this particular investment strategy is more concentrated on identifying and pursuing investment which promises the best returns (Bowen & Booth, 2011). Besides, this shows that this particular research strategy is focused on investment with huge payout hence, ensuring the investors get more that what they invested (Lim, 2011). On the other hand, active investments are usually funds which are run by an investment research team who are given the mandate to make all the decision regarding to investments, whether to buy or sell different assets by the investor. In this investment strategy the investor benefits from the investment expertise and experience, extensive knowledge and skill as well as extensive access to research in different sectors, markets and extensive investment based network (Investopedia, 2014). The active investment strategy is better than the passive investment strategy since it aims on delivering superior returns that those in the market as a whole. On the other hand, this type of investment is quite conservative hence it is quite ideal compared to passive investing having that it guarantees the protection of capital and its loss of value in case of a fall in the markets is quite high (Shankar, 2011). Another benefit of active investing as compared to passive investing is that the actively managed investments tends to offers higher return than those provided by the market. Thus, with the availability of an expert in this investment strategy an investors’ money is well invested through making the right calls. Since the goals and objectives of most investors is for their investment to achieve higher returns hence a clear alignment of these goals with those of active investments strategy making it even more ideal (Speidell, 2016). The active investment strategy is also more ideal since its more useful in specialized areas such as emerging markets, healthcare, technology and smaller companies which are best suited for this investment strategy due to their need for expert in finance and investing (Trudeau, 2014). This therefore guarantees further investment in more promising areas such as health care ad technology. The active investment strategy is considered to be timid and not willing to embrace risk therefore limiting it possibility of higher pay outs compared to passive investment strategy (Wild, 2013). The active investment strategy is more ideal compared to the passive approach since it entails taking up a hand-on approach through following ones instincts or taking advantage of short-term price fluctuations or insights from a deep analysis which might pay off hugely in the long end (Yao, & Wermers, 2015). However, for the passive investment strategy this is not the case. This strategy revolves around following a particular stipulated framework for fear of huge losses therefore they payout are relatively minimal. 3. Evidence for passive investing (against active investing) Passive investing focuses on mutual and exchange-traded funds (ETF) that represent a market index proportion. The passive investment strategy is considered as a cautionary investment strategy therefore there is a limited possibility of it to present risks which would jeopardize most investors’ funds that have been pumped into a particular investment (Ellis, 2017). Further, the passive investment strategy also guarantees a certain level of security on an investment as opposed to the active investment strategy which is characterized by high risks. The passive investment strategy questions the ability of active managers in consistently outperforming their bench marks. As opposed to the active investment strategy the passive investment strategy acknowledges the fact that these managers and experts are human therefore they are bound to make mistakes which may lead to transfer of losses or risk to the investors investments (eZonomics, 2010). However, for the active investment strategy this fact is not acknowledged and in case of a mistake by these managers or experts the invested funds by the investors might end up being lost. Passive investment strategy is also ideal compared to active investment strategy because it has relatively lower managerial costs which are in regards to the transactional fees and annual management charges. In this case, the services of these funds managers and experts in passive investment strategy are not as high as those in active management where they are granted the mandate to make all the decision pertaining this investment strategy (Crook, 2010). The passive investment strategy on the other hand entails a long haul investment. Therefore, the investors are guaranteed of a gradual increase in their investment with a minimal loss risk. Hence, this makes the passive investment strategy more cost-effective compared to the active investment strategy (Flood & Ramachandran, 2013). Additionally, passive investment strategy is also ideal because of the buy- on –hold mentality which revolves around it. This means that the possibilities of losses are quite minimal since it does not advocate for the investment temptation of reacting or anticipate every move of a stock market which might lead to miss timing hence causing unforeseen losses (Buser, 2015). Passive investment strategy is more ideal compared to the active investment strategy since in cases where an investor invests more money he is guaranteed a substantial amount in returns from these tiny investments which have gained interest. 4. Own opinion about whether I believe investors should invest actively or passively, based on the evidence presented Despite the perception that the capability of fund managers and experts would thump a basic index fund further reviews on the superficial performance results suggest that passive investment strategy worked best for majority of the investors. Personally, I think that investors should invest in passive investment strategy since it as more guarantee on low level of risk on their investment (Blanchett, 2010). Moreover, I think that the main priority for investors while making any investments is to cut on the losses or the possibility for them to lose their investment and maximise on their returns. Basing my argument on this analogy I tend to favor the passive investments strategy since it is characterized by focusing on lowering the loss risk of the invested funds (Crook, 2010). Study after study for over a decade have showed a significant rate of disappointing results for the active managers who are based on the active investment strategy. In line with this, studies have also showed that the rate at which actively managed mutual funds perform is better than the passive index funds which is significantly low. Thus, the passive investments strategies are characterized by ultra-low fees since no one is picking stocks making its oversight relatively less expensive (Bowen, & Booth, 2011). Passive investment is also characterized by transparency making it clear of the assets in an index fund. Passive investment strategies are also characterized by tax efficiency, meaning that the buy-and-hold strategy does not result to massive gain I capital annually. Some of the advantage of active investment strategies is that flexibility allows the active managers to use manipulation in an effort to ensure the interest earnings are more. The other advantage of active investment strategy is that through hedging active mangers could use a variety of techniques for instance short sale to ensure the interest earned is more (Blanchett, 2010). However, judging by the advantages of the active and passive investment strategies the advantage for active investment strategies tend to rely more on luck since they all depend on particular techniques and strategies which are not guaranteed. Therefore I believe investors should invest in passive investment strategies. In conclusion, both the passive and active investment strategies have a lot of potential for investors with each having its pros and cons. It is also evident that these passive and active investment strategies have different characteristic with the passive investment strategies focusing more on lowering the risk potential in investment and the active investments strategy seemingly focusing on a higher pay out with relatively high risk for loss. Since investment majorly prioritizes on lowering the potential of risk the passive investment strategy is more ideal for investors. References Blanchett, D. (2010). Do Passive or Active Investors Make Better Asset Allocation Decisions?. The Journal Of Index Investing, 1(2), 74-80. http://dx.doi.org/10.3905/jii.2010.1.2.074 Bowen, J., & Booth, D. (2011). Active versus Passive Investing. The Journal Of Investing, 2(1), 11-13. http://dx.doi.org/10.3905/joi.2.1.11 Buser, S. (2015). On the Optimal Mix of Active and Passive Investments. The Journal Of Portfolio Management, 41(4), 91-96. http://dx.doi.org/10.3905/jpm.2015.41.4.091 Crook, M. (2010). A Stochastic Portfolio Perspective on Utilizing Active and Passive Fund Management. SSRN Electronic Journal. http://dx.doi.org/10.2139/ssrn.2170776 D. Ellis, C. (2017). The end of active investing?. Ft.com. Retrieved 6 May 2017, from https://www.ft.com/content/6b2d5490-d9bb-11e6-944b-e7eb37a6aa8e eZonomics, I. (2010). What is active (and passive) investing?. eZonomics by ING. Retrieved 6 May 2017, from https://www.ezonomics.com/whatis/what_is_active_and_passive_investing/ Flood, E., & Ramachandran, N. (2013). Integrating Active and Passive Management. The Journal Of Portfolio Management, 27(1), 10-19. http://dx.doi.org/10.3905/jpm.2000.319782 Fraser-Sampson, G. Intelligent investing (1st ed.). Investopedia. (2014). What is the difference between passive and active portfolio management?. Investopedia. Retrieved 6 May 2017, from http://www.investopedia.com/ask/answers/040315/what-difference-between-passive-and-active-portfolio-management.asp Lim, P. (2011). Investing demystified (1st ed.). New York: McGraw-Hill. Shankar, S. (2011). Active Versus Passive Index Management. The Journal Of Investing, 16(2), 85-95. http://dx.doi.org/10.3905/joi.2007.686415 Speidell, L. (2016). Frontier Market Investing: Active Versus Passive. The Journal Of Investing, 25(4), 20-26. http://dx.doi.org/10.3905/joi.2016.25.4.020 Trudeau, M. (2014). Active or passive investment - Which?. Which.co.uk. Retrieved 6 May 2017, from http://www.which.co.uk/money/investing/types-of-investment/guides/unit-trusts-and-oeics/active-or-passive-investment Wild, R. (2013). Index investing for dummies (1st ed.). Hoboken, N.J.: Wiley. Yao, T., & Wermers, R. (2015). Active vs. Passive Investing and the Efficiency of Individual Stock Prices. SSRN Electronic Journal. http://dx.doi.org/10.2139/ssrn.1573357 ­ Read More