Active versus Passive Investing

By Jon Scott

In this article we’ll cover:

  • What is active investing

  • What is passive investing

  • Different types of active investing (strategic vs tactical)

  • When is active investing better? When is passive investing better?

  • How to pick which is right for you

Active Investing

Active investing involves the buying and selling of investments in order to realize returns that outperform an index or benchmark.

Active management includes investment vehicles such as ETFs, mutual funds, stocks, and bonds.

Pros of Active Investing

Flexibility: Since actively managed funds aren’t tied to specific indexes, the investment manager is able to pick and choose stocks or bonds to be included in the fund.

Risk Management/Hedging: Due to their flexibility, actively managed funds are able to help manage risk by selling specific holdings. Additionally, actively managed funds can use short sales, put options, and other methods to help minimize losses.
Opportunity to (significantly) Beat the Market: Since active investments are not tied to indexes, there is an opportunity to see much larger returns than the market.  

Strategic vs. Tactical Investing

Strategic: Strategic investing involves taking into account your risk tolerance and time horizon. For example, a 25-year-old will most likely invest in a portfolio composed of upwards of 80% stocks versus bonds until they reach an age where their investment horizon and risk tolerance change (i.e. the individual reaches their late 50s and prepares to enter retirement).


Tactical: At its simplest, tactical investing involves timing the market. However, tactical investing is extremely difficult and largely ends up underperforming long-term, strategic investing.

Passive Investing

Involves index-style investing focused on buying and holding assets for long periods of time. Unlike active investing, the portfolio manager is not consistently buying and trading securities in the fund.

Pros of Passive Investing

Lower cost: Passive investing typically charges lower fees than active investments due to the fact that passive investing is a hands off approach to investing.

Transparency: Since this investment is attached to an index, investors are able to identify what holdings are included in the fund at all times.

Decreased Risk: Passive investments are typically more diverse than active investments, which helps protect against downside risk.
Returns: Passive investments when held for a long period of time almost always provide higher than returns compared to active investments over a 20-year period.

Cons of Passive Investing

Lack of flexibility: In times of market losses, indexes provide little to no flexibility since the holdings cannot be changed in real time.


Lack of huge returns: Since index funds are diverse and usually tied to an index, even very successful passive investments will not see returns as large as very successful actively managed investments.

When to use Active vs Passive

Active Investing

  • Short-term goals: Investors with a limited time horizon under two years will want to lean towards active investing.

  • Outsized returns: For investors who want the potential for outsized returns, active investments provide the opportunity to see much larger than average returns.

  • Portfolio diversity: For an investor with a large number of passive investments, active investments provide diversity to a portfolio and can even be a source of gains in a bear market.

Passive Investing

  • Long time horizon: Investors with a long time horizon (two years or more), will want to choose passive investments. The longer the time horizon, the better.

  • Lower risk tolerance: Investors who want to minimize potential for losses will want to steer toward passive investments for the fact they typically see smaller losses than active investments

  • Maintaining income: Investors, especially those in retirement, who want to maintain their income over time (and do not need outsized returns) should prefer the relative stability of passive investments over active investments.

The Bottom Line

In many scenarios, an individual should have both active and passive investments in their portfolio. However, the percentage of passive versus active investments will depend on the individual's age, financial situation, and financial objectives.