Active and Passive Investing
The Term “Investing” or “Investment” has been defined by several experts.
As per Wikipedia – To invest is to allocate money in the expectation of some benefit in the future.
One of the definitions of Investment in Investopedia is - “Investment” is an asset or item acquired with the goal of generating income or appreciation.
In simple words investing means to spend money or time or energy (or any other resource which one has) with the intention of generating profit or additional benefits. The underlying purpose of investing is always profits / benefits.
The term is popularly used in connection with money or finance as a resource. Hence, we have heard our friends and relatives “investing” in bank deposits or in stocks or in mutual funds or in insurance policies. Those who have larger amounts invest in real estate. People who are adventurous or those who have knowledge about such things invest in coins, art, wine, stamps, etc.
As we have seen earlier, the underlying intention behind making an investment is always profit. And most people like to earn a good profit on the investments made by them.
Investing can be of several types. One such type which we look at in this article is Active and Passive investing.
As the words suggest “active” and “passive” are styles of investing.
Active investors are those who are continuously observing the market and monitoring their investments closely. The asset classes invested by such active investors are normally equity or related instruments. Even within the equity class these investors would prefer to invest in specific scrips. Normally their period of holding would be short term. Their strategy is to identify investment instruments whose price movement tends to fluctuate more, so that they can make their profits by using those price movements on a short-term basis.
Active investors tend to get involved in the investing process on a regular basis. They like to watch the price movement of the investments and take decision based on such movements on a short-term basis. Such decisions could be related to making additional investments, stopping ongoing investments, partially or fully exiting the existing investments, etc. If they are hopeful of the investment giving a good return over a period of time, but presently showing a tendency to lose price, they may invest additional funds in that asset class. If they feel that the investment is good over a period of time, but not sure what the short-term movement could be, they may decide to stop ongoing investments, if any. Or if they feel that there exist alternative investment avenues that is likely to give a better rate of return compared to the specific asset they are presently invested in; they would prefer to sell the existing investments and reinvest in the alternative asset. In other words, an active investor in addition to closely monitoring the market also takes decision of buy and sell on a more frequent basis.
On the other hand, Passive investors are those who are not much given to reacting to market movements on a daily basis. Their period of holding is normally long term. Their strategy is to identify investment instruments which they feel would be stable over a long term. Passive strategy can be followed for both investments in the debt or the equity category. In the case of debt category, the investment product could be a traditional debt product like a bank deposit, Insurance policy, Provident Fund Account, etc.
Having invested the funds in a bank deposit or an insurance policy or a provident fund account, the investor normally does not look into this product till the maturity period of the same. This may vary from few months to several years.
A passive investor who wants to invest in the equity category, tries to identify scrips or mutual fund schemes which give a good return over a long-term period. Alternatively, many passive equity investors prefer to invest in an index-based instrument. An index-based instrument replicates the components of the index and gives exactly the same return which the index gives.
Active and Passive styles of investing should however not be mixed up with Aggressive and Conservative styles of Investing, which we would see in the next article.
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