Investors can employ two different strategies when choosing how to invest their money: passive or active. Despite the fact that active investing has historically been most popular, there’s recently been a shift that’s put passive investing way above active in measures of popularity. To illustrate, look at figures from 2013: passive equity funds exceeded $60 billion in net investments, while active funds only had $3.4 billion.
Bear in mind that while these investment strategies can apply to all types of securities, for sake of ease in explaining, we’re going to only look at investing in stocks. Let’s look at a few examples to pull this apart.
Active Investing vs. Passive Investing
In 1900, Glenn Barker had two options when it came to investing in stocks: he could pick his own stocks (on the basis of impulse, personal research, or perhaps a tip he’d gotten in passing) or he could consult a securities broker who would advise him on his choices.
In 1950, Larry Blackwell had more choices than Glenn did. In addition to Glenn’s options, Larry could hire a professional money manager to choose which stocks to invest Larry’s money in, or he could enter into a publicly offered fund and have the fund manager make investment decisions for the group (which would ultimately affect the return on his investment).
Both Glenn and Larry were actively investing, because whether their investments were direct or through mutual funds, the goal was for the stocks they’d put their money into to perform well.
Fast forward to 1999, and meet Charles Mayer, an investor at the turn of the 21st century. In addition to the active investing strategies that Glenn and Larry both had, there’s a new option available to Charles: investing in index funds. Index funds allow either individuals or institutions to invest in wide market segment, and doesn’t restrict the investment to specifically chosen stocks. Investing in an index fund is a passive investment.
Today, Victoria Kimball decides to invest in a fund that tracks the S&P 500 Index, which is an index based on the market capitalizations of 500 large companies with common stock listed on the New York Stock Exchange (NYSE) or NASDAQ. The fund holds the stocks in the index, and as the broad market goes up and down, so too does the value of Victoria's investment in the index.