In our What are the different investment types blog, we talked about some of the assets that are most commonly invested in including stocks, funds and ETFs. If you need a refresher on what these are, definitely check it out!
When it comes to funds they can be run in one of two different ways. Funds can either be active or passive, and this makes a huge difference to the type of investments they contain, how they perform, and how expensive they are in terms of fees.
Active investing is an investment strategy where a fund manager is responsible for selecting the investments — or holdings — that go into a fund. Their aim is to try and beat the market, either by selecting assets that they think will outperform the market as a whole, or by taking advantage of price fluctuations when buying and selling. A fund can contain company stocks, bonds, property and even other funds!
Investors who invest in an active fund are largely making a decision about whether they think the fund manager will be able to beat the market or not, as the success of their investments is tied to the quality of the fund manager’s decisions. A fund manager may actually be a team of fund managers and they will also work with a team of fund analysts, who will help them assess what to invest in and when.
As you can probably tell, active investing is very hands on, and an active fund requires multiple individuals working within it to be able to operate. For this reason, active funds can be expensive to invest in, with anywhere between 0.5% to 1% of an investor’s money being retained by the management team in the form of fees. Over time, fees can really add up, so if you’re thinking of investing in an active fund, it is a good idea to do your research on not just the fund itself, but also the team running it.
All funds have a benchmark, usually an index, so that you can evaluate how well a fund manager has performed over time. It helps to review performance over mid- long-term time periods and screen out any short-term noise and remember to make sure you’re checking performance net of fees to get an accurate idea of how investments have performed.
Of course, past performance is not an indicator of future performance, so keep monitoring your investments at regular periods, remembering that what counts is the long-term trajectory of your investment and not any short-term blips.
Passive investing, as the name suggests, is a far less hands-on investment approach. Whereas the active investor’s objective is to try to beat the market, the passive investor is simply trying to replicate it. Passive investors are largely uninterested in the rise and fall of the market or in price fluctuations, and are instead trying to buy and hold as broad a cross section of the market, for as long as possible.
A hugely popular passive investment method is to invest in index funds. Created by Jack Bogle in 1975 — Jack is also the founder of the low-cost investment manager Vanguard — index funds replicate the holding in stock market indices. A stock market index is a fancy term for a grouping of stocks in areas of interest, or to meet specific criteria.
Two indices you may have heard of are the FTSE 100, which is made up of the 100 biggest publicly traded companies in the UK stock market, and the S&P500, which is made up of the largest 500 companies in the US stock market. The Dow Jones, the DAX and the brilliantly titled Nifty Fifty are other examples of well-known indices. There are also more esoteric indices tracking banking stocks or tech stock etc.
By owning a replication of the stock market rather than trying to pick a few high performing ones, the passive investor expects to do as well as the market does, over time. Broadly speaking the stock market grows about 7% a year, which means that every £1 invested at this rate can be expected to double every 10 years. Index funds are also cheaper to run than active funds and do not require a manager or a team of analysts to run them. As a result, the amount you can expect to pay in fees is much lower, often coming in at less than half a percent.
You may, at this point, be wondering whether to take an active or passive approach when it comes to investing. This is a personal decision and comes down to the amount of research you are willing to do on different fund managers and their track records. If you take an active investing approach you could outperform the market in one year or the next, but research has shown that this this is difficult to achieve over the very long term. On the other hand, if you choose to invest passively, your investments will only perform as well as the market does, which means that in years when the market falls, you could see the value of your investments fall over the short term.
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