Active versus passive investing: the basics

Investing is about trying to grow your money over time, although returns are never guaranteed and markets can fall as well as rise. While there are many ways to invest, two key approaches are often discussed and continue to divide opinion.

One is known as active investing and the other is passive investing.

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What is active investing?

Active investing typically involves investing in funds or investment trusts that are managed by professional fund managers. As the name suggests, active investing involves professionals taking a hands-on approach to managing investments.

Fund managers decide which assets to buy or sell, how much to invest in each, and when to make changes to the portfolio in an attempt to deliver better returns than the market average - based on research, analysis, and judgement.

Pros of active investing

• Potential for higher returns - active fund managers aim to beat a specific benchmark, such as a stock market index like the FTSE 100. There’s a chance that their decision making pays off, beating that market index and boosting returns.
• Flexibility - active managers can adjust portfolios in response to changing market conditions. They may reduce exposure to certain sectors, hold cash during uncertain periods, or take advantage of emerging opportunities that passive investments might miss.

Cons of active investing

• Higher costs - active funds rely on ongoing research and frequent decision-making, so they typically come with higher charges than passive investments. These higher costs can reduce overall returns, especially if performance doesn’t exceed the benchmark.
• No guarantee of better performance - many active funds fail to outperform the market over the long term, meaning investors may end up paying more for similar or lower returns than a passive alternative.

What is passive investing?

Passive investing aims to mirror the performance of a certain market index - such as the FTSE 100 or S&P 500. Passive investments are commonly known as index funds or ‘tracker’ funds. These investments differ from active investments as they don’t rely on a fund manager to actively pick a portfolio of shares.

For example, a FTSE 100 tracker fund invests in all 100 companies in the index, holding each one in proportion to its size. If the index rises or falls, the value of the investment is designed to move in line with it.

Pros of passive investing

• Cost-effective - passive investments have no managers to pay, therefore they typically come with lower charges. Lower fees can make a meaningful difference to long-term returns, especially over time.
• Transparency - passive investments offer a clear view of what you’re invested in because they aim to track a specific index. This means you can easily see which markets, sectors, or companies your money is exposed to at any time.

Cons of passive investing

• Limited returns - a passive fund is designed only to mirror the performance of its benchmark. In simple terms, passive investing will never outperform the market - it can only match its returns.
• No active protection in downturns - since passive investing delivers the returns of an index, if the index performs poorly, the investment will do the same. Passive investments don’t have a fund manager actively making decisions to reduce losses, such as selling or switching assets during a downturn.

Which approach is right for you?

Active investing may appeal more to you if you’re aiming for higher growth, want to generate income, or believe that skilled managers can add value beyond what the market delivers. Passive investing may suit you if you’re happier to sit back and let the market do the work at a relatively low cost.

Some investors use both. They include active funds as part of a broader approach, while combining them with passive investments to help balance costs, risk and potential returns. But the right choice depends on your goals, how much risk you’re comfortable with, and how involved you want to be.

Read: Investing vs saving: the basics
Read: 3 ways to maximise your chances of investing success
Read: Tools that can make you a better investor

Important information: investors should note that the views expressed may no longer be current and may have already been acted upon Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.