If you are considering investing in the stock market or you have been investing for retirement, you've no doubt considered the merits of active vs. passive investment strategy. Before you know which is best for you, you must determine your long-term goals and your investing strategies. Ask yourself what you hope to achieve through your investments, how much effort you want to put into choosing stocks and how much risk you can handle.
Passive Investing
If your answers to these questions suggest that you are risk-averse, you're either not passionate about investing in the stock market or your main goal is investing for retirement. In this case, a passive investment strategy may make sense for you. In theory, passive investing generally delivers a nice return over a longer period of time. It's based on the assumption that the stock market tends to move upward over the long-term, meaning prudent investments may be more likely to pay off. Passive investing requires very little direct management and is generally lower risk.
Active Investing
Active investing, on the other hand, seeks to maximize short-term stock market fluctuations. As an active investor, you try to exploit the minor ups and downs in the market, buying stocks that drop and selling them when they go up again. It takes more of your time to manage active investments and requires a degree of judgment and skill. If you have trouble understanding how the stock market works, active investing may not be for you. Also, since the potential pay-off is larger, it carries greater risk.
Risk Applies to Both Types
Even if you are a passive investor, you are still vulnerable to the fluctuations of the market, and there is no such thing as a risk-free investment. But you can take steps to reduce your risk. Remember to select those stocks that seem best able to increase steadily over the long term. You should not expect sudden high returns, and these stocks may not be as glamorous. You should also diversify your investment portfolio. That way, if one company or one sector in which you invest faces trouble, your portfolio will take less of a hit since you have invested in other sectors as well. Last of all, consider adding such relatively lower-risk investment instruments as bonds.
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