Shiva Sachaphimukh from Farnam Tree gives his insight.
All investing takes form in either a passive or active manner. Knowing the distinction will help you determine what is more appropriate in reaching your goals.
They are two sides of the same coin, and have some stark differences. Passive investing means you purchase an instrument that is a replica of the market you wish to invest in. For example, a passive investment into the Thai stock market means that you purchase the entire Stock Exchange of Thailand (SET) Index.
Active investing is anything that differs from the index. If you purchase shares in a publicly listed company, you are partaking in an active strategy and hope to do better than the overall market (index).
Passive Investing Is a Simple Means to an End
Investing strategies that are passive want exposure to an already-existing basket of investments. This can come in many shapes and forms. In equities, investors looking for passive exposure to the Thai market can purchase a basket replicating the SET Index. Similarly, there is an index for global equities that investors can purchase.
One element that distinguishes passive investing from active is that the human element is carved out. Passive investment funds do not require fund managers that select specific instruments that end up in your investment basket.
This results in lower fees, and this is driving more investors to invest passively. According to Bloomberg, passive investment funds are set to surpass active investment funds worldwide, in terms of assets under management, by 2026.
Passive investing is an excellent way to achieve broad market exposure and diversification. For investors looking for a ‘buy and forget’ type of approach, this is a great option as you only need to concern yourself about market returns and not whether the instruments in the basket are superior to other available options.
Active Investing is More Deliberate
As the term suggests, active investing is more hands-on. Investment decisions with this approach are made with a particular goal in mind.
Everything in investing is relative, and there is always the passive alternative to invest in the index instead. Therefore, prudent active investing is best served by seeking an objective not otherwise available by investing in said index. For example, this can take the form of wanting to achieve higher-than-market returns, or lower volatility than the index.
Whilst there is no right or wrong, we believe that investors need to have a sound reason for pursuing active strategies over passive. Why complicate matters unnecessarily if you do not have reason for it? The next time someone tells you about a great stock tip they have, ask them why they are not just investing in the market index instead?
This is important because active investing by nature opens you up to a higher range of outcomes. You may achieve great returns if things go well, and the flipside is also true whereby your losses may be higher.
Factor in Costs and Your Time When Deciding
One of the primary distinctions between active and passive investing lies in decision making and costs. Active investing requires substantial time and effort to research and analyse investments.
At the same time, a highly-active investor may incur more capital gains tax and brokerage fees while a passive investor does not. However, while a passive investor may prefer not to make decisions, if you don’t monitor your portfolio at all, this can lead to imbalances over time. In such an instance, certain investments may become a large part of the pie, leading to higher volatility.
SHIVA SACHAPHIMUKH is a Director and part of the investment team at Farnam Tree. He is a licensed Investment Consultant with the Thai Securities and Exchange Commission (SEC).
Farnam Tree is a boutique investment and wealth management firm based in Bangkok. The company is a licensed Investment Advisor under the Thai SEC and Ministry of Finance.