Activity is usually rated positively in business, while passivity is often presented worse. But does that also apply to financial investments? And what about securities trading? Is it always better to act quickly than to wait patiently? Does activity beat passivity? Here you can find out what passive investing actually is – and how it differs from active investing.
What does passive investing mean?
A buy-and-hold strategy is pursued with passive investing. This means that it is a long-term investment strategy. Market timing, i.e. speculating on phases of price loss or price increase (so-called bearish and bullish phases) when buying and selling stocks, hardly plays a role in passive investing. The same applies to stock picking, i.e. targeted investing in individual stocks of listed companies.
The question arises: How do passive investment strategies work when neither market timing nor stock picking are important? Passive investing is speculating on the long-term growth of markets. In contrast to active investing, it is not about “beating the market”, i.e. being better than the benchmark index, but about mapping the market.
How does passive investment work – and what do you invest in?
Passive investing generally does not involve investing in individual securities or stocks in listed companies or in funds actively managed by fund managers. Instead, investments are made in so-called ETFs (Exchange-Traded Funds) and above all in passively managed index funds. It is speculated on the long-term growth of the indices.
What is the difference between passive and active investing?
Good to know: The Sharpe ratio or the Sharpe quotient is often used as an important indicator for the ratio of the excess return on an investment to the respective risk.
In active investing, in contrast to passive investing, there is speculation on “beating the market” in terms of performance. Active investment strategies are about outperforming the respective index as a benchmark and achieving an excess return.
Important methods in active investing:
- Stock picking : the targeted purchase of particularly promising securities
- Market timing: buying or selling at the optimal time
In order to benefit from even minor price fluctuations, it is important to closely monitor the market and its fluctuations (volatility) and to act quickly. In day trading , for example, financial products are often bought and sold again in a very short time window. Here investors speculate on quick chances of profit, but must also expect an increased risk of loss.
Discover more information about trading stocks as well as helpful tips on buying stocks .
What are the advantages of passive investment strategies – and what are the disadvantages?
As with other investments, there are also advantages and disadvantages to passive investing. However, not all pros and cons of active investing apply to all investors, as they depend on the respective investment goals and the life situation of the investor.
For example, if you are looking for quick returns and are not afraid of risk, active investment strategies are probably more positive than passive ones. The following comparison of the advantages and disadvantages of passive investing compared to active investing can only serve as a guide, but must be compared with your own investment strategy.
- Less time consuming than active investing: Since there is no demand for quick purchases and sales, the market does not have to be constantly monitored – that saves time.
- Distributed risk through diversification: Since passive investing generally does not involve investing in individual companies but in ETFs, the risk is spread across numerous companies.
- Lower fees than with active investing: ETFs usually have significantly lower fees than funds, where there is usually a 1 to 5% issue surcharge (except for funds with no issue surcharge ) plus ongoing fees.
- Let time work for you: If you invest longer, the probability of a loss decreases.
- There are no emotional decisions: When investing actively, investors often make very emotional decisions and under time pressure – this can lead to wrong decisions. With passive investing, ad hoc decisions are not required, so that emotionally charged short-circuit actions become less likely.
- Plan more time for profits: unlike active investing, passive investment strategies are not geared towards short-term, but rather long-term profits – so quick profits are rather rare.
- The risks of ETFs are quickly underestimated: Especially ETFs that do not track stock indices but rather smaller markets can increase the risk for investors.
- Optimal entry and exit times are difficult to predict: Since market timing is usually not taken into account in passive investing, optimal times for purchases and sales, i.e. phases of a bear market or bull market, can be missed. As a counter-argument, it is often cited that the long investment period is more decisive than the time of investment.
- Missing short-term highs: While active investors can benefit from quick profits (with higher risk), passive investors have to be patient.
- There is no tension: When investing actively, emotions can boil – even in a positive sense, for example with unexpected returns and dividends. Passive investing is quieter – adrenaline junkies won’t get their money’s worth here.