I’m going to keep this short and sweet as it’s already been done to death but it is critical to understand the difference between the two.
Active investing is all about picking stocks, or buying a managed fund where someone is making decisions about what equities to invest in. As someone is making the effort, and may be doing this for a job, they will want to get compensated for it.
This is why you will see management fees that can be 1.5-2% annually, and often also come with an entry fee that may be 5% of your original capital.
You may think these are not big percentages but I am going to show you how they can really add up!
Passive investing – as Investopedia describes it:
“An investment strategy involving limited ongoing buying and selling actions. Passive investors will purchase investments with the intention of long-term appreciation and limited maintenance.
Also known as a buy-and-hold or couch potato strategy, passive investing requires good initial research, patience and a well diversified portfolio.
Unlike active investors, passive investors buy a security and typically don’t actively attempt to profit from short-term price fluctuations. Passive investors instead rely on their belief that in the long term the investment will be profitable.”
Typically the passive investment style that I will be describing utilises Exchange Traded Funds, or ETF’s.
ETF’s can come in many shapes and sizes, in a sense they are similar to a regular managed fund, the difference is that they trade on the open stock markets such as SGX, NYSE, TSX, LSE.
In particular, the ETF’s that I and many others would recommend to follow are products that follow Index Funds, such as the S&P500, ASX200, STI, HSI.
The reason that we follow these Index’s is that they average the performance of the top companies in that market. You are not buying one stock, you are buying hundreds at a very low cost!
It is this diversification that makes this a very safe investment option. Long term you should expect to see 9% returns, and compounded year on year you will retire very comfortably, easily beating inflation.
Before you rush out and just go and buy one of these Index tracking ETF’s, there is still a little more to it to ensure your portfolio safety over the long run.
In the next post I will talk about allocations and how am I making my allocations based on my particular situation.