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Video 11: Active vs passive management - YouTube
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(bright upbeat music)
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[Instructor] There are two major
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investment strategy philosophies:
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active investment management
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and passive investment management.
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Both are very popular
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and you'll find many heated debates
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on the subject of which strategy to use.
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Here's a great way to
understand the basic difference.
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If we look at the S&P 500,
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one of the main stock market indexes
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for the US Stock Market,
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there are 500 companies
that make up that index.
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Let's say that over
the course of one year,
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the S&P 500 index overall was up 7%.
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A passive investment strategy
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would involve just owning the index.
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That means the investor would hold shares
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in all 500 companies
in the same proportion
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that they are weighted in the index.
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So for example, if company XYZ
was 2% of the S&P 500 index,
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then the passive investor would
hold 2% of their portfolio
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in company XYZ as well.
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A passive investor could also just buy
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an S&P 500 index fund,
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which is designed to
track the S&P 500 index.
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The investor would essentially
get the same 7% return
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for the year minus the
cost of the index fund.
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And index funds
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tend to be the cheapest
type of funds to own.
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Let's say that they get a 6.9% return
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on the year after fees.
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All passive investors in the S&P 500
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basically get the same return.
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Someone using an active
investment strategy
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would try to outperform the S&P 500
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in the hopes of getting a higher return
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than 7% for the year.
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Now, as a side note,
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another goal for an
active investment strategy
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might be to get the same
return for less risk.
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But for the purposes of this discussion,
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we'll just use the return
comparison for now.
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In order to aim for a higher return,
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this investor may try
to identify companies
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that they think will do the
best out of the 500 companies
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to choose from.
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Of all the investors
trying to beat the S&P 500
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some will and some won't.
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Some might get a 10% return.
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Some might get a 3% return and so on.
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They may incur higher costs
in the form of commissions
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if they are buying and selling often,
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higher investment fund costs,
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active investment funds
generally charge more
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than passive investment funds,
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and they may have a
higher tax drag as well.
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Active investment management
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can be more time-consuming also.
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Some investors handle
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all their investment decisions themselves
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and others use fund managers
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or services to handle the decisions
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and transactions for them.
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The same can be said for
passive investment management.
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Some passive investors like
to buy index funds themselves
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and get the lowest possible cost.
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Others are willing to
pay a little bit more
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to get some help.
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Many investors use a combination of active
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and passive strategies
in their portfolios.
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For example, some people
might enjoy picking stocks
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from the Canadian Stock Market,
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but use index funds for exposure
to emerging market stocks
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that they are not as familiar with.
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Some investors are
dedicated passive investors.
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They might index all their holdings
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using low cost index
funds for Canadian stocks,
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US stocks, stocks from around the world,
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as well as their fixed income allocations.
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Lower costs are one of
the major attractions
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for passive investors.
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One final note.
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Active trading is a specific type
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of active investment management
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that tends to involve
shorter holding periods
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for individual investments.
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An active trader may buy
multiple stocks in a day
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and hold some for a few days,
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and some for a few weeks and so on.
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But it's also possible to be a
buy and hold active investor.
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You might hold a portfolio of 25 stocks
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and not make any changes for years.
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This technically would be
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an active investment management style
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as your holdings are different
from the overall market
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or index.
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Generally speaking,
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when most people are
talking about the difference
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between active and passive
investment management,
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you can sum it up as this.
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Active investment management
is trying to beat the market,
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and passive management is
trying to be the market.
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(bright upbeat music)
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