Passive vs. Active ETF Investing: Which Strategy is Right for You?

ETF investing can provide you with a solid return in your portfolio. When getting involved in ETF's, you need to decide whether you are going to employ a passive or active trading style. Here are a few things to consider about whether you should invest passively or actively with ETF's.

Passive Investing

ETF's provide a great vehicle for those that wish to passively invest in the market. The ETF was originally invented so that people could easily track the movements of the market. An ETF is typically constructed so that it has all of the securities of a particular index. Indexes typically track the movement of the stock market as a whole. Historically, the stock market has always gone up over the long-term. Therefore, by taking a buy and hold approach to your investments, you can take advantage of the long-term increases in the market. If you try to time the market, you could potentially buy at the peak and end up losing money. Passive ETF investing allows you to purchase shares in an ETF that tracks an index and then ride it to profits over an extended period of time.

Active Investing

For those that enjoy a little more action, ETF's provide a great tool for active investors as well. With an ETF, you can buy or sell them anytime that the stock market is open. Therefore, they are similar to mutual funds in the way that they are diversified, but you can more easily buy or sell them. With a mutual fund, you have to wait until the end of the trading day in order to buy or sell. Therefore, if significant changes take place throughout the day in the market, you will not be able to capitalize on this movement in a timely manner.

Those that engage in active ETF investing are not satisfied with the returns that a financial index can provide. They may recognize that financial indexes do grow over the long-term, but these investors want more. This appetite for increased returns leads them to making more trades. The active ETF investor is trying to take advantage of short-term movements in the market. They try to buy at a low point in the value of ETF and sell at a high point.

Actively Managed ETF's

For the active ETF investor, actively managed ETF's were created. This is an ETF that actually utilizes active management techniques within the fund itself. The fund manager of this type of fund tries to identify securities within an index that can provide superior returns. Instead of equally weighting each investment in the index, they may put more of the fund's assets into a particular stock. In this manner, they try to increase the amount of returns that they can provide to investors. While this does work in some cases, this type of fund also will increase the amount of risk that you have as an investor.