Active investing focuses on trying to ‘pick winners’ – that is, selecting investments that are expected to have the best chance of outperforming the market as a whole. This often involves the use of professional fund managers and financial advisers who identify investments they believe are likely to deliver the best overall returns. Active investors also aim to ‘time the market’ in order to maximise returns and will adjust their asset weightings and exposures to try to take advantage of market surges and contractions.
While an active management style can involve a broad range of methods and techniques – whether it be so-called fundamental analysis of financial performance, technical analysis of trading patterns or macroeconomic analysis of market themes – all these approaches have the common goal of attempting to identify and profit from future investment trends.
Passive investing doesn’t focus on distinguishing between investment opportunities, forecasting likely prices or timing the market. Rather than selecting individual investments in an attempt to outperform a particular market index, passive managers invest broadly within and across the entire index of interest. They effectively ‘buy’ the whole index in which they are interested, allocating their funds across every share/bond in the same proportion that those shares/bonds represent of the index that they are seeking to track. By doing this, passive investors ensure their portfolios mimic the performance of their targeted index. While this means they trade off the opportunity to ‘outperform the market’, it also ensures they avoid the risk of significantly underperforming the market at the same time.