It might even be you’re an experienced investor who could benefit from a reminder about how each one works. This short guide will explain how active and passive investing works, and detail the pros and cons of each.
The main objective of a passive fund is to track the performance of any given market as closely as possible. This is in an attempt to replicate the overall return of that market.
In order to mirror a market, the fund is likely to invest into a wide range of assets that appear in the market index. So this could be from shares to bonds. For example if the fund tracks the UK FTSE 100, it would invest into all – or most of – the companies that are in the FTSE 100.
Passive funds can be a simple way to invest. It can be easier to keep-up with where your money is and what the fund is trying to do. Overall if the market is doing well, the fund should achieve a similar level of positive performance.
Pros and cons
- Passive funds track the market performance. This means they don’t need monitoring as much as an active fund. You’ll still have a team of experts working hard behind the scenes. But the approach taken means it doesn’t cost you as much to invest into a passive fund.
- Bearing this in mind, you’ll typically find that charges for passive funds are cheaper than others.
- Although it’s hard to achieve, it’s still worth noting that in most cases passive funds will not be able to outperform an index the way an active fund has the opportunity to do. (Although of course there’s also a risk that an active fund could underperform the index).
- If a fund falls dramatically, or if economic changes call for a different style of investing, a passive fund is usually not able to adjust its portfolio to match the required changes.
The main aim of an active fund is usually to try and generate greater returns than the relevant market. Other aims may include specifically focusing on limiting losses when markets are experiencing a downturn.
Active funds are managed by a fund manager or team. They make day-to-day decisions on where to invest.
Depending on the objectives of the fund and the manager’s overall approach to investing, the manager has the opportunity to invest into a wide range of assets. This allows them to take advantage of any market opportunities they spot. They can also make moves to protect your capital if assets begin to fall in value.
Pros and cons
- Depending on the fund’s overall objective, an active fund manager may have little or no constraint on their investment choices. This offers a greater flexibility to invest. Meaning the manager is able to select what they consider the most promising opportunities.
- The manager has the ability to make decisions which may limit losses during falling markets. Although, this is usually down to the approach of the fund manager, and the level of risk they’re willing to take. There are also no guarantees these changes will minimise losses.
- With an active fund you’re paying someone to make active decisions. The main aim of these decisions is to usually try and outperform the market. You’ll typically pay more for this expertise, so there are usually higher annual management charges to pay.
- The higher the fee, the more important it is for your fund to perform. If a fund has a 1% annual fee, and the market rises 5% that year, the fund must therefore rise by 6% before fees just to break even.
Mark Elliott, Head of Financial Advice and Risk Research
Our view is that both approaches play an integral role in the world of investing. Each has their own strength and weaknesses. It all depends on your individual circumstances, appetite for risk and financial needs. One important point to make is that if you’re new to investing, then passive funds can be a good starting point for you.
If you’re unsure about your goals, attitude to risk or any investment decisions in general, we always recommend speaking to one of our advisers about making and reviewing your plans. They’ll help determine which method is right for you. They can also recommend an approach to investing that’s tailored to your specific needs.
By investing with Skipton, the aim is to grow your money by a greater extent than is available through cash savings accounts to help you achieve your goals. Although, funds are not like bank and building society savings accounts. It does mean placing your capital at risk, as its value can fall as well as rise and you may get back less than you originally invest. Past performance is not a guide to future returns. Economic and market conditions experienced in the past may not be repeated in the future.