Understanding active and passive investing

Active and passive are two different approaches to investing. Learn how these strategies can affect your investment returns.

Active investing

This is a strategy that involves a lot of buying and selling of investments with the goal of beating the market. With an active managementActive management An investing strategy that makes specific investments to try to get better returns than a benchmark such as a stock market index.+ read full definition approach, success is measured by comparing a fund or portfolioPortfolio All the different investments that an individual or organization holds. May include stocks, bonds and mutual funds.+ read full definition’s returns to a relevant benchmarkBenchmark A yardstick that you can use to measure the performance of an investment. Example: a stock market index may be a benchmark you can use to compare how well your own stocks are doing.+ read full definition.

For example, the performance of an actively managed Canadian equity mutual fundEquity mutual fund A mutual fund that invests in a broad mix of stocks. In most cases, an equity fund won’t invest in any bonds.+ read full definition could be measured against the S&P/TSX Composite IndexIndex A benchmark or yardstick that lets you measure the performance of a stock market, part of a stock market or a single investment. Examples: S&P/TSX, S&P/TSX Canadian Bond Index.+ read full definition, the benchmark index for the Canadian market. Active investors attempt to gain more than the benchmark index when the market is up and to lose less when the market is down.

Investment types

  • Actively managed mutual funds are the most common product for this investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition strategy.
  • There are also actively managed exchange-traded funds (ETFs).

Passive investing

Passive investors believe it’s hard to beat the market with active trading, especially over the long termTerm The period of time that a contract covers. Also, the period of time that an investment pays a set rate of interest.+ read full definition. Instead, they’ll look to match market performance with a passive managementPassive management An investing strategy that generally involves a portfolio of securities that tracks the performance of a benchmark or investment model. The holdings of a fund that is passively managed are only adjusted if there is a change in the benchmark or investment model.+ read full definition approach. They’ll buy investments that track a benchmark index, such as the S&P/TSX Composite Index, Dow Jones Industrial Average, or the S&P 500. Fees could to be lower with this strategy.

Investment types

  • Passively managed ETFs are the most common product for this investment strategy.
  • There are also passively managed mutual funds.

A quick comparison

Feature Active Investing Passive Investing
Performance Provides the opportunity to outperform specific market indices.

 

Delivers returns that match the performance of specific market indices.
Fees Active investing strategies tend to result in higher fees over time. Passive investing strategies could result in lower fees over time.

 

Risk management Active fund managers can attempt to minimize losses during a market downturn by adjusting a fund’s investment mix. Passive funds track a particular index. When the stock marketStock market The collection of markets and exchanges where stocks, bonds and other securities are issued or traded.+ read full definition falls, passive funds fall along with it.
DiversificationDiversification A way of spreading investment risk by by choosing a mix of investments. The idea is that some investments will do well at times when others are not.+ read full definition Active fund managers can assemble diversified portfolios that spread the risk and reward among different assetAsset Something of value that a company or an individual owns or controls. Examples: buildings, equipment, property, a car, investments, or cash. Can also include patents, trademarks and other forms of intellectual property.+ read full definition classes.

Passive funds are a low cost way to be diversified within asset classes and market segments.

Your choice depends on your investing personality

Active and passive investing each have their unique benefits. It doesn’t matter whether you’re investing on your own or working with a financial adviser, you can choose either approach, or do a combination of both. In fact, many advisers will recommend a blend of active and passive styles.

The choice of investing style really depends on your investment goals and what matters to you as an investor. To determine your investing personality, ask yourself these 4 questions.

 

Choose the investing approach that’s right for you: Active investing, passive investing, or a combination of both.

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