Active vs passive investing in volatile markets

Whether the headlines are focused on inflation, interest rates, politics or global events, periods of market volatility may leave you wondering whether your portfolio is positioned appropriately for the future. During these times, you may hear more discussion about two different investment approaches: active investing and passive investing.

Neither approach is inherently better than the other. Both have advantages, and both involve risk. Understanding the differences can help you have more informed conversations about how your money is invested and whether your current approach remains suitable for your goals.

Passive investing aims to follow the performance of a particular market rather than trying to outperform it.

A passive fund typically tracks a market index, such as the S&P 500. Instead of selecting individual companies that may perform better than others, the fund invests in the same companies that make up the index, aiming to hold the same proportions.

One of the main attractions of passive investing is simplicity. Because there is less research, analysis and trading involved, passive funds often have lower charges than actively managed funds.

The philosophy behind passive investing is that markets generally rise over the long term, despite periods of short-term volatility. Rather than trying to predict which companies, sectors or regions will perform best, passive investing allows you to participate in overall market growth.

Of course, tracking the market also means your investments will rise and fall with that market. If the index experiences a decline, the value of a passive fund is likely to fall too, meaning you could get back less than you originally invested.

Active investing takes a more hands-on approach.

Instead of tracking an index, an active fund manager researches companies, industries and economic trends with the aim of delivering better returns than a particular benchmark. They make decisions about which investments to buy, hold or sell, based on their assessment of opportunities and risks.

This flexibility is one of the key differences between active and passive investing. An active manager can adjust the portfolio as market conditions change, potentially increasing exposure to areas they believe offer opportunities or reducing exposure to areas they believe may face challenges.

However, flexibility does not guarantee better outcomes. Active managers can make decisions that work well, but they can also make decisions that prove unsuccessful. As with all investing, the value of your investments can fall as well as rise, and past performance is not a reliable guide to future returns.

Higher market volatility simply describes periods when investment prices move more sharply than normal.

While volatility can feel uncomfortable, it's important to remember that it is a normal part of investing. Markets do not move in a straight line, and periods of uncertainty are often followed by periods of recovery.

When markets become more volatile, the difference between active and passive investing often receives greater attention. Some people believe skilled active managers may be able to identify opportunities or reduce certain risks during difficult periods. Others argue that staying invested and avoiding attempts to second-guess the market is a more effective long-term strategy.

The reality is that no one can consistently predict how markets will behave in the short term.

One of the strongest arguments for active management is the ability to respond to changing conditions.

For example, if a fund manager believes a particular sector faces increasing risks, they may reduce exposure to it. Equally, if they identify companies that appear undervalued during a market downturn, they may increase holdings in those businesses.

Periods of volatility can sometimes create opportunities for active managers to add value through careful research and stock selection.

However, success is never guaranteed. Some active managers may outperform during challenging periods, while others may not. This is one reason why choosing an active fund often involves assessing both the investment approach and the manager's track record, while recognising that past results cannot predict future performance.

Passive funds continue to track their chosen market regardless of whether markets are rising or falling.

This means they will participate fully in market downturns, but also in any recovery that follows. For some people, this can remove the temptation to make frequent changes based on short-term market movements.

If you move out of the market during a period of uncertainty, you may miss out on any recovery should markets rise again.

A passive approach focuses less on predicting market movements and more on remaining invested over the long term. While this may not prevent short-term fluctuations in the value of your portfolio, it can help maintain exposure to future growth opportunities.

While active versus passive investing is an interesting debate, it is rarely the only factor that determines long-term outcomes.

Your financial goals, time horizon, attitude to risk and overall asset allocation are often far more important. Having a well-diversified portfolio that reflects your personal circumstances may ultimately matter more than whether a particular investment is actively or passively managed.

Market volatility can be unsettling, but it is a normal part of investing. Rather than reacting to every market movement, it can be more helpful to focus on the long-term plan you have in place and whether it remains aligned with what you want to achieve.

If you're unsure whether an active or passive approach is right for you, speaking to a financial adviser can help you understand the options available and how they fit with your wider financial goals.

This article is for information purposes only. It is not intended as investment advice.

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