Active vs Passive Investing: Beat the Market or Minimize Costs and Effort?

Buy low, sell high. You might not be The Wolf of Wall Street but there sure is something exciting about the idea of playing a more active role in your investments. 

Look at what happened when 50 Cent took an interest in investing in flavored bottled water. He acquired a small stake in Vitaminwater and suggested they add grape flavor. A few years later, Coca-Cola acquired the company and Fiddy sold his stake for a sweet $100 million, according to Forbes.

Then again, he also went bankrupt a decade later thanks to some not-so-great investments. Herein lies the dilemma of active investing: too often, it's an all-or-nothing game.

If you go the easy, passive route and sock away 10% of your paycheck in a retirement account, it's not going to land you in bankruptcy. In fact, you'll grow a nice little nest egg over the course of a few decades with little to no effort. But it's not going to make you a millionaire any time soon.

So, should you be the CEO of your investments or is it best to Netflix and chill while someone else handles your money? Is active investing better than passive investing? Let the battle commence.

Passive investors are in it for the long game. Popular passive investments include retirement accounts, like the 401(k) your employer might offer, and index funds, which are a collection of stocks that track an index like the S&P 500 and are designed to offer consistent long-term returns. 

These methods are lower on the risk spectrum, and they average annual returns of 10%, which isn't bad. If you start putting away $100 each week now, your investments will be worth almost $90,000 in 10 years. You'll have earned about $37,000 of that off interest alone, and you didn't have to spend any time actively managing your investments.

Investing to hold over a long period of time rather than reacting to the stock market’s fluctuations means you can take your hands off the reins. You don’t need to consistently check the market, withdraw your money, or put any effort in at all. You don't have to worry about choosing the wrong stock, and you also don't need to put in the long hours required to learn enough about stocks and investing to actually beat the market.

Active investing uses an all-hands-on-deck approach with the help of a portfolio manager. An active investor takes advantage of stock market gains in the short-term, aiming to buy when prices are low and sell when they're high. Ultimately, they try to outperform the average return on investment you'd get from a retirement plan or index fund.

In the example above, if you invested $100 each week but managed to achieve a 15% annual return, you'd have about $120,000 in 10 years. That's an extra $30,000 for putting in a little effort—assuming you made some very smart investment choices.

For most of us, attempting to beat the market via active investing isn't all that different from buying a lottery ticket. You need to be able to predict trends and know when an asset is undervalued (time to buy) or nearing its peak (time to sell). You can hire an investment advisor, but they come at a cost and often require you to be willing to invest upwards of six figures. Plus, study after study has shown that even most professionals can't beat the S&P 500.

Passive investing pros

• Beginner-friendly: It doesn't require extensive knowledge or research.
• Low fees: You don’t need anyone to choose your investments, so fees are minimal to non-existent.
• Long-term results: Over long time horizons, passively-managed investments tend to perform better than actively-managed ones.
• Tax efficiency: Passive investing strategies tend to be extremely tax-efficient. Since you aren't buying and selling often, you don't have to pay much in capital gains taxes.

Passive investing cons

• Limited flexibility: While you can adjust your portfolio for risk and when you plan to withdraw your funds, you don't get a say in exactly how your money is invested. Big investment funds aren't going to react to major changes in the market as quickly either.
• No potential for outsized returns: While you're likely to see long-term growth, you'll have to settle for average market returns.

Active investing pros

• Potential for outsized returns: You could earn far more than the standard 10%, and there's potential for growing wealth in the short-term that you won't get from passive investing.
• Flexibility: With an active investment strategy, you can invest in just about anything you want, and you can also switch up your investments at a moment's noticed.
• More customization: Because active investors can put their money where they want, you can actually tailor your portfolio to your needs and interests more accurately than you can with larger passive funds.

Active investing cons

• It's hard to beat the market: With active investing, there's a lot more risk and potential for human error. While you can beat the market, most people don't.
• High fees: Hiring an active portfolio manager costs money, and they usually require a high minimum investment. Even if you go the DIY-route, fees from frequent trading can also add up and eat away at your returns.
• More taxes: You'll probably pay more in capital gains taxes from regularly buying and selling stocks.
• More time and effort: Whether you go with a fund manager or DIY, active investing requires a lot of time and learning upfront to build an effective investing strategy.

From Woody and Buzz to peanut butter and jelly, the most iconic duos balance each other out. A dual passive and active investing strategy is the ideal way to reduce risk while attempting to earn some outsized returns on your investments. By doing this, you get the benefits of passive investing when the market is stable and active investing when it weakens. 

While there's still a learning curve, investing apps make it easy (and cheaper) to get started with both.

WeBull is an easy-to-use platform that gives you access to an extensive range of investments, including stocks, ETFs and crypto. Zero commissions and no minimum investments means you can trade actively without worrying about fees.

Using M1, you can automate your investments for a passive approach or customize them for a more active one. Fractional shares let you buy a portion of one share, so you can buy expensive stocks with very little money to give stock-picking a try. At the same time, you can automate your investments in a way that's tailored to your goals.

Buying shares of valuable collectibles, such as limited-edition sneakers, sports cards, vintage cars, and streetwear, might actually earn you more than the stock market—without having to actively manage your investments. Historically, the most valuable fine art has outperformed the S&P 500 by 250%, and you can invest in shares of it through platforms like Masterworks.

Collectible trading cards have also outperformed the S&P 500 over the past 12 years, and you can invest in those along with some of the world's most legendary sneakers with Public.

Zero-fee real estate platform Diversyfund allows you to invest in REITs that offer target returns between 11 to 18%, which is significantly higher than average stock market returns. Plus, they purchase and manage the properties for you, so it's entirely passive. Investing starts from just $500, allowing you to earn monthly dividends from property without having to do the hard work of being a landlord.