Active Versus Passive Investing — The Differences & What Works for You

Revisiting the tortoise versus hare fable to understand the differences between active and passive investing

Remember that fable about the tortoise and the hare? Of course, you do. All of us have read this story when we were in school and learned the famous moral that came with it — Slow and steady wins the race. Who can forget that classic, right?

Well, let’s explore it with a few twists and turns. The tortoise and the hare, once again, set out on a race. Both of them have the goal to reach the finish line. There is a main road from the starting point to the finish line, and the tortoise sets out on it. The hare, though, is not satisfied with taking the obvious route. It wants to improvise to try to reach the finish line quicker.

The hare sets out on the main road, but keeps looking for other connecting roads that could lead to the finish line. It explores shortcuts and different routes. While the hare does all of this, the tortoise is simply walking on the main road towards the finish line.

Here, unlike the original fable, both the tortoise and the hare do reach the finish line. Both of them are winners, but what’s different is how they win. This is also the difference between passive investing and active investing.

In our story here, the tortoise is the passive investor while the hare is the active investor.

What is passive investing

Passive investing is the type of investing where you follow a fixed path. In investment jargon, this is called following a fixed strategy that involves minimal involvement. Investing in an index fund or an ETF that tracks an underlying index is an example of passive investing. This underlying index could be the Nifty or Sensex or any other benchmark index.

Another example of passive investing would be investing in a fixed strategy that requires just some minimal and pre-determined involvement, like a quarterly or annual rebalance

In our story, the main road taken by the tortoise would be the underlying index that it is following. The tortoise knows that this road will take him to the finish line and all it wants to do is follow that road without bothering about anything else. In the same way, a passive investor would invest to follow a specific index and not bother about the rest of the markets.

What is active investing

On the other hand, an active investor, much like the hare, would want to follow a more active strategy to fulfill his or her goals. An active investor wouldn’t simply follow an index. He or she would look for investments in other segments of the markets. The way the hare explored different shortcuts, an active investor would invest in riskier assets in lieu of earning higher returns in a shorter period of time.

Read more on our blog for the differences between the two and why active investing can be riskier.

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