For anyone with an eye on the NASDAQ and S&P500 markets, you might have noticed big global tech names like Apple, Amazon and Google are all up 40-50% year to date. But most notably, the chip maker Nvidia is up more than 150% year to date, all heavily weighing on the overall market direction. Hindsight makes things crystal clear when we see who the winners and losers are after watching companies go boom or bust in unstable markets.
But without a crystal ball to make future investment decisions with, how you choose to participate should ultimately come down to your personal investment goals and tolerance to risk. There are two key investment strategies that both have their advantages and disadvantages, and their effectiveness may vary based on market conditions.
So, which one might be right for you? Active Investment strategy Active investing involves handpicking securities to try to generate superior returns or outperform a benchmark index. It relies on the belief that skilled investors or managers can generate superior returns by closely monitoring market trends and analysing financial data to identify undervalued assets.
Active Investment strategy
The appeal of active investing is the potential for higher returns (for example, if you bought Nvidia shares on the 1st of January 2023). Skilled active managers may outperform market averages, generating alpha returns (returns greater than the index). Active investing also offers the opportunity for personalised decision-making, as investors have direct control over their portfolio compositions. This flexibility allows for tactical adjustments in response to changing market conditions.
What to keep in mind Consistently outperforming the market is difficult as it requires accurate timing, stock selection skills and the costs associated with providing these. Passive Investment strategy Passive investing aims to mirror the performance of a specific index by holding all or a representative sample of securities within that index, mainly through ETFs (Exchange-Traded Funds). In this approach, passive investors benefit from broad market exposure and reduced stock-specific risk by holding a diversified portfolio.
The appeal of a passive investment strategy is in its simplicity, reduced management cost and certainty to achieve a market return.
What to keep in mind
Passive investing is a long-term strategy, requiring investors to ride through the market lows and highs, continuing to remain focussed on the long term goal.
What else should you consider?
Understanding fees and the difference between each strategy is very important for investors as it can impact long-run performance. Being overly active could eat into returns due to transaction costs, and so too can high active management fees (performance fees especially). Conversely, being subject to above-market passive management fees can impede the ability to mimic the targeted market index return.
A common approach in portfolio construction is to incorporate both active and passive strategies. Utilising an asset allocation framework, investors can include active or passive strategies to target the best result within each asset class. For example, using a stock selection method for NZ equity exposures, where the market is smaller so investors can be selective with what to own and what not to own. Whereas for global equity exposures, investors could use passive ETFs to diversify across markets to gain greater depth of exposures. Ultimately, a consideration before chasing outperformance using either an active or passive strategy is to ensure a robust investment plan is in place that reflects investment objectives and risk tolerance. Having structure around when or what to add/reduce or buy/sell can turn out to be far more important to meeting investment goals than being 1-2% above or below the market.
Andrew Atkinson is a Wealth Management Adviser at Jarden’s Hawke’s Bay office where he provides strategic investment advice and portfolio management to individuals, family trusts and charitable trusts. Get in touch if you would like to know more:
www.jarden.co.nz or +64 6 877 9074
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