Investing for your retirement is one of the smartest decisions you'll ever make! This guide will teach you how to do exactly that.
With the investment landscape taking over the world, an increasing number of people are looking out for options to put their money into the market and have it grow substantially over time. Slowly but steadily, wealth building is becoming a common practice.
Keeping that in mind, it becomes crucial to discuss the two most important concepts of the investment world – active and passive investment. These are the two major ways to put your money on the market. Both active and passive investing target the benchmark indices like the DMF index or the S&P/Hawkamah index and aims to replicate or outdo them.
This article will explore the topic of active vs passive investment in the UAE. Let’s begin by understanding how these strategies work, their pros and cons, and which one suits a certain investor.
The active investment style involves frequent trading with the goal of beating the average return of the index and scoring high-profit margins. You can recall what you have seen in several movies circling the Wall Street operations – active investment is much like what’s shown in these movies and shows. However, given the advancement of technology and digitisation of the world, people can now be active investors from the comfort of their homes using their smartphone applications.
Investment professionals, also referred to as fund or portfolio managers, help the folks who don’t wish to be a part of the investment and trading world themselves. Such professionals can be found with asset management companies that handle mutual funds or exchange-traded funds.
Active investment requires fund managers and active investors to regularly assess the economic and market trends. The major task involved with active investment is to capitalise on the short-term fluctuation of prices of the assets included in any given portfolio. This means that active investment plans can only be successful with constant monitoring and all hands on board.
Let’s cover some common advantages of active investing:
For instance, let’s assume Ms A bought 10 shares of XYZ company for AED 50 each. She also chose to purchase a ‘put option’ for AED 2 with a validity of 1 year. The put option will allow her to sell her shares for AED 48 at any time during the year, meaning that Ms A can beat her potential losses if the market crashes in the next year. If the price of XYZ’s shares increases to AED 60 instead of decreasing, Ms A would stand at a total loss of AED 20 (the price of the put option) but will have unrealised gains worth AED 80 (total – price of the put option).
In this case, purchasing a put option serves as the off-set position for Ms A. She now has a way to sell her shares at minimal losses instead of losing her entire investment.
Given below are a few drawbacks of active investment management:
Passive investment is done with an “in for a long-haul” mentality. The buying and holding action take precedence here and make it a highly cost-effective way of investing. Here, every little fluctuation in the stock market doesn’t trigger an action from the investor. Successful passive investing is about keeping the eye on the final prize and skilfully ignoring the small setbacks that come along the way.
Passive investors generally purchase a passive index fund leading to ownership of shares of multiple companies in a small amount. The major earning of passive investors comes from the profits that companies earn over time by mirroring the market performance of major indices. As there are only a few transactions involved in passive investing, the fees are considerably low as well. The goal of passive investment is to gradually build wealth and grow money.
In passive investment, fund managers create a diverse portfolio of single stocks of different companies that are known as passive index funds. These portfolios aim to match the performance of major market indices, hence offering maximum profits in the long run. Investors can purchase these indices just like how they can purchase and trade stocks in the stock market.
Let’s first go through some advantages of passive investing:
The following are a few limitations of choosing a passive investment strategy:
Let’s get an overview of the two kinds of investment and understand where they stand for each parameter included:
|Parameters||Active Investment||Passive Investment|
|Approach||Active trading||Buy and hold|
|Dealings||Stock portfolios||Index fund portfolios|
|Changes in Portfolio||Frequent changes||No Changes|
|Ways to Invest||Self or via portfolio manager||Via portfolio managers or brokerage firms|
|Returns||High real-time returns||Higher average long-term returns|
|Risk||High risk||Low risk|
|Market Volatility||High volatility||Low volatility|
|Involvement||Active involvement required from investor or portfolio manager||Low level of activity required|
|Fees and Charges||High fees||Low fees|
|Transparency||Low transparency||High transparency|
|Exit Options||Multiple exit option||Minimal to no exit options|
Choosing one of the two kinds of investment methods after careful consideration of your end goals is necessary to ensure that your returns and risk align with your expectations. Picking the wrong investment option at any given point in time may lead to unfulfilled financial goals and return expectations.
Let’s see which investment method is ideal for which situation and how you can make the right choice for yourself:
Active Investment: This style can be ideal for an investor who needs to make money at the moment and preserve their wealth actively. For instance, someone closer to their retirement may want to try actively managed portfolios as they cannot freeze up funds for a longer time with passive investment. Additionally, they may want to secure returns to get an optimum supply of funds during their retirement period. Investors who have a higher risk appetite may also try their hand in the active investing landscape.
Passive Investment: This is ideal for folks targeting money growth instead of quick returns in the short term. Passive investing is known to provide higher average returns over the long term. Moreover, since passive investment strategy lowers the risk significantly, it makes for a good option for investors with a low-risk appetite who cannot afford to lose their base investments.
Hybrid Investment Model: Several experts argue that a good blend of active and passive investment portfolios is ideal for investors. The age-old concept of active vs passive management of investments is shaping into a new idea which shows that a diverse portfolio of both these investment methods can help you effectively achieve long-term goals like building a retirement fund. People who are nearing retirement may also try their hand at a hybrid investment model – one part would allow them to grow wealth steadily while the other will ensure active income with short-term returns.
Despite a few drawbacks of both options, planning and strategizing well can help in creating a money-sustaining portfolio. Naturally, it is important to have a fund manager who can understand your requirements properly and allocate money to assets accordingly.
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