December 5, 2025: Active vs. Passive Investing

What is the difference between active and passive investing strategies? Which one is “better?” Which one is right for my personal finances?

Fund managers and advisors may explain that their investments follow either a passive or active strategy. Knowing the difference between the two can help you make an informed decision for what makes sense for you.

Passive Investing

This is likely the most familiar strategy. This method takes a “hands-off” approach and is usually seen as a “boring” way to invest. Passive investment strategies attempt to emulate market returns by investing in a broadly-diversified portfolio and not making bets as to which company, sector, or country will outperform. Passive investment strategies typically track an index (like the S&P 500, Russell 2000, or Dow Jones Industrial Average) and therefore will not outperform the market. This strategy often has lower costs, fewer trades, and broad diversification. This strategy fits well with a buy-and-hold investment philosophy.

Active Investing

This is likely the most tempting strategy. Active investing means buying and selling based on a variety of factors which boil down to trying to outperform the market or an index. Active investors attempt to take advantage of market inefficiencies to sell overvalued investments and to purchase investments that are undervalued. This strategy can hold highly concentrated positions, use leverage, and trade frequently all with the goal of outperforming the market. This strategy requires significant time and resources - and a high risk tolerance! It’s not a guarantee that this strategy will outperform the market and it may underperform for long periods. Trading costs, capital gains taxes, and leverage can further eat into investment returns.

So, which strategy is “better?” The answer is that both strategies can have their place in an investor’s portfolio.

Passive investing makes sense for many people. If you have a long time horizon, want to keep trading costs low, and are satisfied with market returns then passive investing will often make sense. People don’t often have the time or resources to dedicate to active investing. Keep in mind - passive investors have no chance of outperforming the market since they simply track it.

Active investing strategies are often used by highly-sophisticated and well-funded firms which make them out of reach for the average investor. Active investing often underperforms passive investing. However, certain active strategies are not too costly and can improve investment returns. For example, tax-loss harvesting (written about in a previous newsletter) requires active monitoring and trading, but is an effective tactic even for the average investor. The focus of this newsletter has been on stocks, but an active strategy is effective for bonds. A simple example is buying a portfolio of individual municipal bonds issued in your state to take full advantage of the tax-free nature of municipal bond interest, rather than buying a municipal bond fund which contains bonds from other states that don’t provide this benefit.

Think carefully about each of these strategies and consider what makes sense for your situation.