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Passive vs Active Investing: Which Strategy Is For You?

The key step to grow wealth is to understand the difference between passive vs active investing.

First, let me ask you a couple of questions. 

  • Are u a long-term or short-term investor?
  • Can anything exist in the middle?
  • Which investment strategy should you use?  
  • What’s more profitable?
  • Is the risk tolerance high or low? 

With attention to these questions, I’m going to answer them and even more…

Introduction to Passive vs Active Investing

In fact, there is always a heated discussion on this topic. 

When I’ve studied the investment strategies of ultra-rich people, I suddenly recognized my direction. 

As a result, some kind of indescribable sage appeared in my brain that made a decision between passive vs active investing.

“After all, I’ve been devoting a lot of time investing in myself. By the way, you must also first invest in yourself – unquestionably.”

And it was clear for me in which of these two investment strategies I want to build wealth. 

So read on to the end of this video to find out my unique view and opinion.

For now, let me explain how I see a fundamental difference between passive investing vs active investing as well as something in the middle. 

Yes, you hear it right.

There is a bridge between passive vs active investment management strategies.

That being said, 

let’s kick off this article with a long term investment strategy which is passive investing. 

Passive Investing

Passive Investing

Look, 

You may have heard gazillion times term “Buy & Hold.”

To explain, it’s a type of philosophy or mentality and it’s simple as it sounds. 

In general, you buy a few asset classes here and there and no matter what market does, you ride it.

Why?

Because you assume it will grow over time.

But my point is this:

  • Are you an emotional character? 
  • Or are you emotional in nature?

What I mean by that is…

When the market is up, your guts are full of butterflies.

Moreover, you feel that you are the best investor with the best stocks of the century, and you want to brag to everyone how well-performing is your portfolio.

On the flip side, when the market is down…

  • Are you panicking? 
  • Do you sell? 

Pause here a while and think about your character because it’s part of this topic.

And that’s what I mean to be emotional…

While investing you are an emotional character

Listen,

when the global pandemic hit the world in 2020, I talked to people about their assets.

Why?

Because I’m usually curious about people’s emotional reactions. 

Without any surprise, I found that some of them were really panicking and selling their assets.

And to make me even more surprised, they don’t realize the market cycles. 

“Certainly, the market cycle might last a long time, but look, the market will recover anyway…”

Even though these folks were in their thirties and forties so enough time to rebalance, reallocate and recover the portfolio. 

So…

What Is The Solution?

The absolute number one key solution is diversification

The absolute number one key is diversification

So how to diversify? 

The truth is, it’s not as simple as it used to be.

While studying the ultra-rich people and their investment portfolios, I discover a pattern with the basic 3 keys of asset allocation.

1. Diversification Across Asset Classes
2. Diversification Across Markets
3. Diversification Across Time

Yet there is more to know…

But for now, let’s discuss these three asset allocations. 

1. Diversification Across Asset Classes

Diversification Across Asset Classes

Speaking of diversification number one, a long-term investment portfolio has to include various types of asset classes

You may ask, what they can be? 

“First and foremost, it’s about to know your risk tolerance and how much time you have.”

Then you decide whether to invest safely or aggressively if you are at a younger age. Because you will have more time to recover. 

How To Invest Conservatively

So conventional wisdom says:

When you want to be conservative, you should choose actively managed mutual funds with intermediate or long-term fixed-income bonds. 

Wrong!

Why?

Because these mutual funds have usually higher expense ratios with other fees that will gobble up your wallet every year. 

“Instead of mutual funds, look at low-cost index funds or ETFs that have much lower fees.”

Next, you can explore low-risk assets such as structured notes or market-linked CDs

Market-linked CDs are usually buried assets for every-day investors because they don’t realize their existence. 

But it can be an absolutely worthy exploration because of achieving strong returns while betting on security.

How To Invest Aggressively

On the other hand,

when you are willing to bet on growth and take more risk, your investment will fall usually within individual stocks, more aggressive mutual funds, index funds, or ETFs. 

And as I said before,

in the first place, it’s better to choose low-cost index funds or ETFs to decrease fees.

And the second reason is, you don’t need to bet on an individual one stock company. 

Now, what about real estate assets?

Real estate is a broad asset and you may have many choices to pick from. 

Because buying a whole piece of real estate might be expensive for some of you or you don’t want to manage it. 

Instead, you can choose publicly traded REIT which stands for Real Estate Investment Trust and collect quarterly dividends. 

Or even if you feel comfortable with crowdfunding real estate platforms. 

2. Diversification Across Markets

Diversification Across Markets

Now, when speaking of second diversification across markets, I’m talking about domestic, foreign, developed, or emerging markets. 

Again, you can choose mutual funds, index funds, or ETFs and allocate a certain percentage of your investment across these markets. 

3. Diversification Across Time

Diversification Across Time

And third diversification across time is the best approach by applying a dollar-cost averaging strategy. 

Let’s say, you set up biweekly or monthly an automatic investment of $500 across your asset classes. Simple as it sounds. 

So to summarize passive investing, let’s have a look at benefits and drawbacks.

Benefits And Drawbacks Of Passive Investing

An advantage is,

“Passive investing is a hands-off strategy.”

You don’t need to be daily involved, but instead, maybe twice per year review and rebalance your portfolio.

On the other hand,

the downside of passive investing in mutual funds is that it’s not under your control. Because you let managers manage your portfolio and you trust them. And they eat up a lot of your fees.

The best advice is to find a dependable fiduciary that acts honestly on behalf of the client.

Now let’s briefly discover something between. 

I call it…

Passive-to-Active Investing

Passive-to-Active Investing

Passive-to-active investing usually applies to the private equity market as an angel investor or venture capitalist

And here is the fact:

Let’s imagine, you invest in a startup through a syndicate or crowdfunding platform.

This might sound like passive investing because it’s a hands-off strategy and you won’t usually see your money a few years. 

But the key is…

“If you are an experienced active angel investor, you might actively help the founders of the startup in a certain direction.”

Now, I don’t mean to dictate how to run the company. What I mean by that, instead, you may help in a certain area of your skills.

It could be:

  • User acquisition,
  • Logistic resources,
  • Interior design,
  • Or just spreading the word of mouth – you get the point. 

You see,

even if your money is locked for a long period, it’s not just passive investing.

But you can be quite active and you might get privilege at the table with key shareholders and investors. 

So this is a fundamental investment strategy that lies in the middle between passive vs active investing.

And lastly, let’s talk about:

Active Investing

Active Investing

Until now, we’ve spoken about passive investing…

But what is active investing?

Or who is an active day trader?

Sometimes you can stumble upon activist investors as well. 

“The simple truth is that active investing or day trading is short-term speculation.”

Do you remember what I said at the beginning about gut feeling and risk tolerance? And what I said about an emotional character? 

If not, go back to the beginning.

Because active investing, it’s much more intense… 

Why? 

Active investing requires a daily hands-on approach. 

It means that someone either you or let’s say the portfolio manager tries to beat the time and market. 

But let’s assume, you possess strong technical trading analysis skills. 

Strong technical trading analysis skills

Next to that, you are a super active Doer and you may sometimes be successful in beating the market.

As a result, you might be pumped to sit a few hours behind the screen and trade currencies, forex or stocks. 

Well, if this is for you, good luck. 

Or another scenario… 

You might be in your twenties and you want to jump into the world of house flipping.

For that reason, you find an ugly deal, but with brilliant numbers. And you close the deal, fix the property and sell it.

My question is,

  • How would feel about that?
  • Is this something that you would like to explore? 

Well, again, if this is for you, good luck… 😉

So, to summarize active investing, let’s have a look at benefits and drawbacks.

Benefits And Drawbacks Of Active Investing

Speaking of advantages,

you can hedge your trading bets by using various techniques called “put options” or “short selling”. 

“Other benefits of active investing can be tax strategies, as you can sell the assets you are losing and offset them with your big gains.”

On the other hand,

The drawback of active investing

the drawback of active investing is that it’s riskier, stressful, emotional, and it can trigger mental uncontrollable disorder with addiction.

Needless to say, it might be expensive because of the fees. Because all these fees can really kill your return…

So now, what are the three biggest key takeaways? 

Three Key Takeaways

1. Passive Investing is a hands-off strategy and you are willing to ride the market for the long term. And it doesn't require you to buy and sell daily asset classes. 
2. Passive-to-Active Investing is locking your capital for a few years up to a decade. It's very risky but the return might be staggering. It could be both hands-on and hands-off strategy.
3. Active Investing is a hands-on strategy by executing daily activities either by you or some portfolio manager. The goal is to beat the market and time.

That said, both passive and active investing as well as passive-to-active investing is beneficial. 

For that reason, I’m a long term investor and I never try to beat the market.

My opinion is, active investing is stressful while passive might be more popular. 

So hands-on or hands-off investing strategy is totally up to you. 

Time To Take Massive Action

Now is your turn.

  • What’s your best-performing asset class and why?
  • Which market are you investing in?
  • Are you trying to time and beat the market?

Write in the comment “investing” as I know you are a true Doer and loyal fan. 

Because I want you to take action and become a Doer.

I look forward to seeing you soon.

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About the Author

Vlastimil Cícha

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