Active and passive investing explained!

There is a growing debate as to whether Warren Buffet and mega money managers like Vanguard are right when they discuss investing strategies.

Jack Bogle
John Clifton “Jack” Bogle is the founder and retired CEO of The Vanguard Group.

And in case you might have missed that debate, the central issue is fees.

Passive investing supporters like Buffet and Vanguard founder, Jack Bogle argue that there is no benefit to the investing public when it comes to paying too much money over to ‘active’ investors. Those are the guys that spend a lot of their time buying and selling stocks and bonds in order to ‘beat’ the market and generate a higher rate of return to their customers.

Bogle and Buffet believe it is more profitable to take a less active approach, a passive approach. They argue that it is impossible to beat the market long-term and those that do only do so for a very short period of time, their luck runs out and over time, their rapid fire buy-sell approach actually costs investors huge sums of money unnecessarily.

For Buffet and Bogle, the math is overwhelmingly in their favour.

When I talk to investors and students, explaining the concept of active and passive investing can be a little daunting. At first, I tried to simply present the maths and while this worked in offering the science, it didn’t fullyy explain the real difference between the different approaches.

Until yesterday!

While out on a run, I experienced the difference.

It was about 7pm and traffic was heavy.

What I noticed was that I was getting to the next set of lights at the same time as two particular cars. This lasted for just two sets of lights. And this reminded me of another driving experience through Manhattan a few years ago. Provided you drive at a particular rate of speed, it is possible to hit a majority of green lights all the way from lower Manhattan to the top end of the island. This is passive investing.

When I did that drive across Manhattan, I noticed another car that sped from light to light. It got caught at every red light. And at the end of the cross-island drive, I was still next to it. The other driver was active investing; speed, spurts and stops and along the way, getting no further, using more fuel and probably risking a speeding ticket.

For some investors, there can be a certain romance in the concept of the Wall Street type adviser. But like that driver that dashed from light to light, they are usually more sizzle than substance.

When it comes to growing your money there are many investment options to consider. But when it comes to investing approaches, there are only two; active or passive.

The maths support a passive approach all day for the sheer size of the investment return potential over time.

At the end of the day, this is broadly the better option to securing more long term wealth growth…and putting money in your investment account (including pensions).

Frank Conway is a Qualified Financial Adviser and Founder of the MoneyWhizz, the financial literacy initiative 

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