When we are talking about strategy, there are two strategies being practiced by investors, namely: Active and Passive Management. By definition, an active management is a strategy adopted by investors in the attempt to out-perform the market through the allocate of assets, whereas passive management seeks to deliver the returns of an asset class or sector of the market.
Active management might best be described as trying to apply a variety of techniques to find good deals in the financial markets. Active management is the main model for investment strategy today. Active managers try to pick attractive stocks, bonds, mutual funds, and time when to move into or out of markets or market sectors and place leveraged bets on the future direction of securities and markets with options, futures, and other derivatives.
Among the benefits of active management are:
- Flexibility – because active managers, unlike passive ones, are not required to hold specific stocks or bonds
- Hedging – the ability to use short sales, put options, and other strategies to insure against losses
- Risk management – the ability to get out of specific holdings or market sectors when risks get too large
- Tax management – including strategies tailored to the individual investor, like selling money-losing investments to offset taxes on winners.
Passive investors make little or no use of the information active investors seek out. Instead, they allocate assets based upon long-term historical data delineating probable asset class risks and returns, diversify widely within and across asset classes, and maintain allocations long-term through the periodic rebalancing of asset classes. The best-known method is index investing that tracks the results of any benchmark index, like S&P 500.
Among the benefits of passive investing are,
- Very low fees — since there is no need to analyze securities in the index
- Good transparency — because investors know what stocks or bonds an indexed investment has
- Tax efficiency — because the index fund’s buy-and-hold style does not trigger large annual capital gains tax.