Investors need to make a very important decision when it comes to an investment philosophy. It doesn’t matter what type of investment is purchased, the philosophy of the investment plan will still be determined by this decision. There is no escaping this decision, even if you hire an advisor to help you with your investments. This decision needs to be made whether you are investing in stocks, bonds, gold, real estate or your brother-in-law’s tire business.
Active management, or speculation, is when you try and beat the market through calculated guesses. You are guessing which investments are the “right” ones and avoiding the “wrong” ones. You’re also trying to time the market. But for timing to work, you need to guess correctly twice, when to get in and when to get out. Get one of those wrong and you can lose money.
Passive management doesn’t try to beat the market; it tries to capture the market’s return. Passive management seeks to maximize diversification and focus on keeping costs low in order to achieve greater optional returns. Passive management has no guess work, no right or wrong investments or when to get “in” or “out” of the market.
Fees and expenses tend to be higher with active management than passive because there is more daily activity in active management. Active investments need to be monitored more closely to make sure the correct decision is made at the correct time. If you believe that you can predict the future successfully on a regular basis, then active management might be the way to go, but if not, passive might be for you.
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