Knowing the difference between active vs. passive investing shapes portfolio management strategies and impacts your potential to earn more money. A clear comprehension of actively managed funds and passive funds is crucial. Moreover, aligning your investment philosophy with your financial goals and risk tolerances. Let’s look at these two investing strategies to help you figure out which one is closer to your investment persona.
What is Active Investing?
Active investing is generally described as a hands-on approach that involves individual or fund managers making specific investment decisions, such as selecting stocks, with the aim of outperforming the market. In active investing, managers utilize various strategies, including market timing, asset allocation, and in-depth analysis (both fundamental and technical), to identify investment opportunities and make buying or selling decisions.
This approach often involves more frequent transactions and consequently incurs higher fees and expenses compared to passive investing. The goal of active investing is to achieve returns that are superior to those of the broader market through the skilled management of a portfolio’s holdings.
Examples of Active Investing
Investing in the Stock Market
Individually managing your own stock portfolio and investing in the stock market involves purchasing shares of publicly traded companies with the expectation of capital appreciation and potential dividends. Investors analyze company fundamentals, market conditions, and economic factors to make informed decisions, seeking to achieve long-term growth and diversification.
Hedge funds are actively managed investment pools that employ various strategies to generate returns. These strategies can include long/short equity positions, derivatives trading, and alternative investments. Hedge funds are typically open to accredited investors and aim to provide absolute returns, often with lower correlation to traditional markets.
Traditional Real Estate Investing
Traditional real estate investing is acquiring physical properties, such as residential, commercial, or industrial buildings, for rental income and potential property appreciation. Investors manage property maintenance, tenant relationships, and financing to generate cash flow and long-term asset appreciation.
Advantages of Active Investing
- Potential for Outperformance: Active investing offers the potential to outperform the market averages, as it enables fund managers to leverage their skills, knowledge, and experience to identify investment opportunities that can yield superior returns, exploiting market inefficiencies and capitalizing on short-term price fluctuations.
- Customized Investment Strategies: Active investing may allow for a more tailored and flexible investment approach. Investors or fund managers can align the portfolio with specific goals, risk tolerances, and investment philosophies, adapting the investment strategy to changing market conditions, economic developments, or individual preferences.
- Risk Management: Actively managed funds often benefit from professional oversight, which may allow for the implementation of sophisticated risk management strategies. Active fund managers can navigate market volatility, adjust asset allocations, and use various techniques to mitigate risks, potentially safeguarding the portfolio against substantial losses during market downturns.
Disadvantages of Active Investing
- Higher Costs: Active investing typically involves higher fees and expenses due to the ongoing management, research, and transaction costs. These higher costs can significantly impact the net returns, especially when the investments do not perform as well as expected. Hedge funds, for example, can charge you 10 to 20% of your earnings as performance fees on top of their management fee. In contrast, the CWS Investments mortgage note fund has zero management and performance fees.
- Risk of Underperformance: Despite the goal to outperform the market, many actively managed funds fail to beat their benchmark indices. The risk of underperformance, coupled with higher fees, can result in lower net returns for investors compared to passive alternatives.
- Tax Inefficiency: The frequent buying and selling of assets within actively managed funds can lead to higher capital gains distributions, which may be taxable to the investors. This tax inefficiency can further erode the net returns for investors in high tax brackets.
- Subject to Managerial Risks: The performance of actively managed funds is heavily dependent on the fund manager’s skills, knowledge, and judgment. A wrong decision or missed opportunity by the manager can adversely impact the fund’s performance, which may expose investors to managerial risks.
What is Passive Investing?
A passive investment strategy takes a hands-off approach to investing. Such strategies depend on the steady appreciation of the value of assets or metrics that do not need the fund managers to actively and continuously analyze asset performance. For instance, bonds have a fixed rate of return over a specific period of time. This rate is unlikely to change because of government security.
Another example is the CWS investment structure. When you invest in our mortgage fund, you may receive an aimed annualized return of 8 – 10% on your investment. Passive investors are keen on generating content income without the hassle of frequently analyzing the performance of their capital. They will also look for investment strategies that are less volatile to reduce the anxiety of risk and investment loss.
Examples of Passive Investing
Mortgage Note Funds
A mortgage note fund pools together capital from investors to buy distressed mortgage notes from a secondary market. The aim of this strategy is to purchase performing notes that are heavily discounted and create a new restricted plan for the mortgage borrower.
This restructured payment plan will provide income and profit which will be distributed to the investors accordingly. CWS Investments aims to distribute investor returns as monthly dividends at an annualized rate of 8 – 10%. Would you like to learn more about the high-yielding potential of mortgage notes? Schedule a consultation call with Chris Seveney right now.
Index funds aim to replicate the performance of market indexes, offering passive investors exposure to a broad sector of the real estate market with lower fees. Passive mutual funds allow individual investors to achieve a diversified asset allocation with lower expense ratios, emphasizing long-term growth and tax management.
Real estate crowdfunding platforms have emerged as a modern avenue for passive investing. These platforms allow you and other investors to pool funds to invest in real estate projects managed by experienced fund managers. This form of investment provides an opportunity to enjoy the benefits of real estate investment, such as income and appreciation, without the responsibilities of property management.
Advantages of Passive Investing
- Lower Costs: Passive investing generally involves lower transaction, management, and operating costs compared to active investing since it does not require frequent buying and selling of assets or intensive management. Lower costs can translate to higher net returns over time.
- Tax Efficiency: The lower transaction turnover in passive investing usually results in fewer taxable events, making it more tax-efficient. This efficiency is especially advantageous for investors in taxable accounts as it helps in preserving wealth.
- Broad Market Exposure: Passive investments like index funds and ETFs offer investors broad exposure to a diversified range of assets or entire market segments, helping in reducing unsystematic risk and providing a more stable and predictable return profile over time.
- Consistent Returns: Since passive investing aims to mirror the market or a specific market segment, investors can expect consistent returns that align with market performance, avoiding the risks associated with the potential underperformance of active managers.
Disadvantages of Passive Investing
- Limited Potential for Outperformance: Since passive investing strategies aim to replicate the performance of a market index, they generally do not have the potential to outperform the market. Investors are bound by the returns of the index or asset class they are tracking, missing out on potential opportunities for higher returns through individual security selection and market timing.
- Lack of Flexibility: Passive investing does not allow for adjustments based on market conditions, individual security performance, or economic developments. This lack of flexibility means that investors are fully exposed to any downturns in the market or specific sectors, without the ability to mitigate risks through active management decisions.
Active Vs. Passive Investing: Which is Better?
As you deliberate between active and passive investing, the choice you make should be influenced by your risk tolerance, financial goals, and the desired level of involvement. Speak with a financial advisor to determine what investment vehicle fits your needs, wants, and desires.
Passive strategies generally align with the investor’s desire for tax efficiency, lower costs, and reduced management responsibilities. Actively managed funds often entail higher fees, justified by the premise of achieving superior returns through strategic portfolio management programs.
Ultimately, the choice of strategy is dependent on you. Understanding the types of investment options within each concept, how they work, and their advantages and disadvantages, puts you in a better place to make an informed decision on how to go about your investment.
Are You a Passive Investor? Consider Mortgage Note Investing
Investing in a mortgage note fund is a great strategy for you if you are looking for a hands-off approach to investing. It is also less time-intensive because all the day-to-day operations of your investment will be managed by professionals at your partner company.
CWS Investments offers alternative investment strategies by purchasing mortgage notes for investment purposes. We have created a fund that pools investment capital to purchase distressed mortgage notes from the secondary market at a significant discount. Our investment portfolio spans 40 US markets and our team is dedicated to performing due diligence on each individual note. In return, we aim to provide investors with an 8 – 10% annualized return through dividends which are distributed monthly. If you’d like to learn more about the benefits of mortgage notes as a passive investment strategy, talk to a member of our team today. .
Frequently Asked Questions about Active Vs. Passive Investing
1. What is passive vs. active investment income?
Passive investment income typically refers to earnings derived from ventures where the investor is not actively involved, such as monthly dividends from mortgage note investing. In contrast, active investment income involves earnings where the investor plays a hands-on role, such as profits from buying and selling stocks in actively managed funds or managing a business.
2. What is an example of a passive investment?
An example of a passive investment is mortgage note investing. Mortgage note investing involves purchasing and holding promissory notes secured by real estate. This can be done individually, or through a mortgage note investment fund. When a property owner borrows money to buy real estate, they sign a note promising to repay the loan, and this note can be sold to investors. Mortgage note investing can be an alternative means of investing in real estate, providing opportunities for diversified income streams and, depending on the note’s terms, potentially higher returns compared to other real estate investment options. For more information about mortgage notes contact CWS Investments today.
3. How do I start passive investing?
To start passive investing, begin by setting clear financial goals and risk tolerance levels. Consult with a financial advisor to choose suitable passive investment vehicles that align with your financial objectives and risk appetite, and then invest consistently over time, focusing on long-term growth.Once established, you can consider various passive investment options like index funds, ETFs, or mortgage note investing.
4. Is passive investing high risk?
Passive investing is generally considered lower risk compared to active investing, especially over the long term, due to its diversified nature and lower costs. However, the level of risk in passive investing still depends on the specific assets and market indexes that the investment tracks. It’s crucial to assess individual investment products, their underlying assets, and market conditions when evaluating risk levels in passive investing.
5. Who manages the fund in passive investing?
In passive investing, the fund is typically overseen by a fund manager or a management team. Their primary role is to perform due diligence on investment assets before incorporating them into the investment portfolio.