Active vs. passive investing. What's the difference?

What’s active investing for retirement?

Active investing is a strategy that requires you to have a more hands-on approach. Active investors buy and sell investments to try to outperform a benchmark—in many cases, a stock market index. Actively managed mutual funds and exchange-traded funds (ETFs) use this strategy to do the same.

Advantages

• Flexibility—Active investors buy and sell investments when they think they'll benefit financially. This can be helpful during volatile times when short-term opportunities to make money may present themselves. 
• Increased return potential for the risk—An active investing strategy has the intention to outperform the market. 

Disadvantages

• Higher cost potential—Actively managed funds tend to have higher investment managements fees (IMFs).
• Success can be challenging—It takes knowledge about investing and ongoing monitoring of your investments to be an active investor.

What’s passive investing for retirement?

A passive investing strategy tries to match the performance of a benchmark rather than beat it. The S&P/TSX Composite Index¹ is an example. It tracks the performance of the largest companies in Canada, in key industries, listed on the Toronto Stock Exchange.

It’s accessible to investors mainly though funds and ETFs that track its composition. The success of a passive investor can be measured by how closely their returns align with their desired benchmark.

Passive investing requires less decision-making and trading than active investing does. You don’t choose how much of one company to invest in within an index—the index defines it for you. For example, if the S&P/TSX Composite Index replaces 10 companies, to continue to meet the guidelines of the index, an S&P/TSX Composite index fund will swap out the same 10 companies.

Advantages

• The success of the companies in the fund determines returns—Passive investment returns are tied to the performance of the companies in the index over the long term. 
• Lower cost—The cost to passively invest is often less because you’re not making as many transactions.

Disadvantages

• Missed opportunities—The major disadvantage of a passive strategy is that you may miss out on short-term opportunities to make money. 
• Investment limitations—When you passively follow an index such as the S&P/TSX Composite Index, you don’t have the opportunity to invest more money than the index does in a specific company or sector.

Which strategy is right for you?

With a do-it-yourself approach to managing the investments in your group retirement plan, you might choose some funds that are actively managed as part of your investment mix along with some passive funds. This approach is best taken by people who are knowledgeable about investing and willing to take the time and effort to manage their retirement funds.

If you don’t have the knowledge or time to manage your retirement funds, you may want to invest your group retirement savings in ready-made funds, such as target-date funds or asset allocation funds. These funds offer you a choice among different investment time horizons or risk profiles, and leave the management to the experts. 

How should you invest for retirement?

Group retirement plans normally offer a variety of investments to suit different types of investors. Even if you choose a ready-made strategy, it’s still important to review your investments on a regular basis to be sure they’re performing well and aligned with your strategy.

When you’re deciding how to invest for retirement, give some thought to:

• Your level of investment knowledge
• Your investment goals
• When you want to have access to your money 
• How much risk you’re willing to accept

Active and passive investing strategies both have their benefits and drawbacks. You may find that both have a place in your investment strategy, depending on your unique financial goals. 

Consider connecting with a financial advisor if you’d like ongoing help.

1 The S&P/TSX Composite Index is the benchmark Canadian index, representing roughly 70% of the total market capitalization on the Toronto Stock Exchange with about 250 companies included in it. The Toronto Stock Exchange is made up of over 1,500 companies.