Becoming an investor sounds challenging. Joining the Warren Buffets of this world might require millions to invest, expert knowledge of the machinations of markets in general and intimate understanding of individual businesses.
But it does not have to be this way. In fact, you can become a successful investor without having more than the most basic understanding of the stock market, by using a fund to take care of investment for you.
At Continuum we are looking at the differences between passive and active stock market investment via fund investments.
Diversification, which simply means holding a wide spread of stocks, is a sound principle when you are planning your investment portfolio. A fund is a very efficient way of giving yourself exposure to a broad range of stocks, because buying into a fund means that you are automatically buying a spread of investments. If the fund manager is doing their job properly they will have carefully structured their holdings with investment to give you all the benefits of diversification, even if your actual investment is very small.
Funds can be invested according to a number of criteria. They may simply be aimed at providing a high level of returns, or at cautious investment – or they may be focused towards a specific sector of the market. For example, technology focused funds give you exposure to a fast moving sector, while still providing the benefits of managed investment. You can choose the fund that matches your interests and attitudes.
You will pay a fee to be part of the fund, but the benefits of diversification and the services of an expert manager can make the cost more than worthwhile
The difference between passive and active funds
Funds can be passive or actively managed.
With an active fund, the fund manager picks specific stocks to fulfil the objective of the fund, which is basically to get the best return possible, subject to the constraints the fund operates to such as the sectors it operates in, and the level of risk that is acceptable.
He or she will constantly update the stocks held in the fund to take advantage of opportunities and dispose of holdings that are underperforming.
With a passive fund, the manager creates a basket of stocks which largely don’t change. So a passive fund might be designed to track the performance of the FTSE 100 as closely as possible. It will do this simply by investing in every FTSE 100 share. When a share drops out of the FTSE 100, the fund would automatically sell it and buy whatever stock replaced it. A passive fund is called an index fund if it tracks a stock market index, or a tracker fund if it’s following another metric.
So, which is right for you?
Instinctively, active funds might appear to offer the best performance. An expert manager will spend each day doing painstaking research to select the best investments.
If they do their job well, they should be able to beat the market and provide you with a return that is in excess of a tracker fund because more care is given to the choice.
A fund manager may be able to read a situation developing in the market based on their experience and knowledge. It could mean an actively managed fund can drop stocks before problems turn into losses and take on exciting new holdings before the rest of the market discovers them.
But things may not be so simple. Studies have shown that some active funds can do extremely well, but others struggle to match the market overall. What’s more, although some managers may have a better track record on creating wealth, beating the market in a single year or a couple of years can be down to luck. Past performance really does not guarantee future returns.
What’s more, the cost of running a managed fund can be much higher than a passive fund and the costs will be passed back to you as an investor. Higher fees eat into the profits you enjoy from a managed fund.
Investment can be complicated and having an expert to call on and ensure that the investments you make are right for you needs expertise. Call us at Continuum for the expertise you need to make your investments work harder for you
Getting some help
So is passive or active investment best for you? The answer may depend on your experience, the scale of your financial objectives and the time you have for your investment scenario. But it is simple to get help. For expert advice on the approach that is right for you and to find the funds that are best placed to deliver it, call us at Continuum.
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable investment strategy, you should seek independent financial advice before embarking on any course of action.
The value of investments can fall as well as rise and you may get back less than you invested.