Should I choose active or passive investments?
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Richard Barker, Chartered Financial Planner with Smith & Pinching, advises on different investment strategies.
I’m in my early forties and normally have surplus income which I either spend on extras or put into an investment portfolio that I have begun to build up using a large national financial advice firm. I have about £150,000 invested so far in what they call passive investments. I wonder if I might be better going for something that’s a bit more dynamic as I am investing for the longer term so can afford to take a bit more short term risk. What do you think?
Richard Barker of Smith & Pinching responds:
An investment strategy can involve passive and active investment assets. A passive investment fund simply aims to track a market or match a benchmark rather than outperform it. For example, the fund might aim to match the FTSE 100. The investment house will set the strategy but there will be no active decision-making in relation to the underlying investments. This generally makes it cheaper than active investment. Passive investing reduces the risk that your investment will underperform relative to the market/benchmark, but it also reduces the likelihood that it will outperform.
With active investments, on the other hand, the fund is generally run by a manager who will buy and sell the underlying investments with the aim to beat the performance of a stock market or to outperform a benchmark. The investment managers will carry out research and use their expertise to make decisions in an attempt to deliver better returns against the market (known as alpha) – or at least limit potential losses (neither of which is guaranteed, of course) if markets fall. The cost of this service is higher than with a passive approach because of the intervention of the fund management team. This is important, because even if performance is better than that of a passive fund, the overall return may be worse after management costs are deducted.
The important point to make is that both active and passive investments can be aligned to your investment risk profile so there is no reason why a change of strategy will expose you to more or less risk. Both strategies can be effective, and both have risks, depending on a number of factors. In fact, we will often adopt a strategy that uses both active and passive elements, known as a blended strategy, where we feel it’s suitable.
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The key to building an investment strategy is to ensure that it is suitable for you in every aspect. Suitability is a word we use extensively in financial services – it’s not just about making sure the risks you are taking are right for you, it’s also about meeting your long-term objectives and aligning your investment portfolio to factors such as your stance on ethical investing, for example. Once you have a strategy, you need to keep your investments under review on a regular basis to make sure they are still right for you in terms of both your preferences and their performance.
This is a complicated area so do talk this through with your adviser. If you are still uncertain, it may be worth getting a second opinion from an independent financial adviser and having a review of all your arrangements.
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Any opinions expressed in this article do not constitute advice. The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested.
For more information please visit smith-pinching.co.uk