Introduction to Investing: Are you an Active or Passive Investor?

For many people who are new to the investment world, it is a complex environment filled with complicated concepts and hard to understand financial jargons. Compound this problem with numerous opinions and advices out there offered by financial “experts”. It is easy to see why many finds investing a daunting task.

In an Internet era where a Google search on “investing” will churn out millions of articles in a split second. It is important to (1) understand the basic approach that you wish to take – Active or Passive Investing – (2) what are the main differences between the two approaches and (3) which is suitable for you as an investor.

Active Investing

Active Investing is the most common form of investing practiced by fund managers around the world. The core aim of these fund managers is to achieve returns that outperform the benchmark index.

‘Benchmark Index’  – a gauge of the performance with regards to a certain stock market. In the index, it consists of stocks depending on the criteria set by the country’s stock exchange. Investors and fund managers will typically use it to compare the performance of their portfolio.

By actively investing, the fund managers are exploiting what they believe are inefficiencies in the markets by buying and selling stocks at their discretion. The kind of strategies available to them includes short-selling, event driven matters and macro-selection. When fund managers actively invest, they have to be constantly aware of the volatilities in the markets and adjust accordingly to it.

Some of the investment products that have an active investing element will include unit trusts. Unit trusts are usually offered through banks or financial services websites. Potential investors should understand the investing objectives of each unit trust before putting their money in.

Some insurance policies such as whole life policies and investment-linked plans will include investments into various type of unit trust. If you have such a plan, which means you may already be an active investor without even realizing it.

Individual investors who are frequently buying and selling stocks in their portfolio can also be categorized as active investors.

Passive Investing

Passive Investing is a form of investing that uses the benchmark index as a gauge for returns. Advocates of passive investing believes that markets are efficient in the long run so there isn’t really much of a point trying to outperform the market (ie: attempt to earn additional returns on top of what the market is giving). Passive investment products usually track the benchmark index.

Take for example; the KLCI ETF (Ticker: 0820EA.KL) is an exchange-traded fund that tracks the FTSE Bursa Malaysia Index, which contains 30 Malaysian blue chip companies. The fund manager is AmFunds Management Berhad, a passive fund manager that handle subscriptions and redemptions of the funds and miscellaneous. Passive fund managers do not actively buy and sell shares.

Common Misconception about Passive Investing

As retail investors, when we entrust our wealth to fund managers by subscribing into a unit trust, we may think we are passive investors since we are not actively involved with the process of selecting and trading stocks. However this investing strategy itself is not a passive approach because the fund manager is essentially appointed to buy and sell stocks on our behalf and at his discretion, as long as it is within the fund’s guidelines. This effectively, is an active investing approach.

Simply buying into an ETF does not automatically make one a passive investor, not if the person is buying into the ETF with the intention of trying to time the market (ie: buy when they feel prices are low, sell when they feel prices are high). An investor who enters into a trade looking to time the market is taking an active investing approach.

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