Passive vs Active Investing

Passive Investing vs Active: Which Approach Should a Novice Choose?

The investment journey often resembles a labyrinth of terminology, numbers, and conflicting advice. At its core, the choice revolves around two opposing approaches: passive investing, where the key to success is "buy and hold," and active investing, which requires constant analysis and decision-making. It's essential for novices to understand not only the basic mechanics but also their personal limitations: time, risk profile, and goals.

Definitions and Principles

What is Passive Investing?

A passive strategy mirrors the dynamics of the broad market by purchasing index funds or ETFs that reflect the performance of specific indices such as the S&P 500, MSCI World, or local indices. The key principles include:

• Diversification of risk through a broad basket of securities.
• Low fees (TER 0.03-0.3% annually).
• Minimal involvement—rebalancing 1-2 times a year.
• Transparency of portfolio structure and rebalancing rules.

Case Study: Ivan, a novice investor from Moscow, invested $1,000 in an S&P 500 ETF at the beginning of 2020 and, despite the market correction in March, achieved a return of +45% three years later thanks to passive holding and reinvesting dividends.

What is Active Investing?

Active investing involves selecting individual securities or strategies with the goal of outperforming the market. The investor or manager analyzes fundamental and technical indicators, monitors macroeconomic events, and regularly adjusts the portfolio:

• Fundamental analysis: P/E ratio, dividend yield, debt load.
• Technical analysis: charts, trend indicators.
• Alpha return: the desire to beat the market.
• Higher costs due to fees and taxes.

Case Study: Maria from London allocated 5% of her portfolio to biotech startup stocks and achieved a +30% growth in a year. However, drawdowns of up to -20% on days of bad news and high fees forced her to reconsider her risk management.

Tools for Passive Investing

Index Funds and ETFs

ETFs (Exchange-Traded Funds) and index mutual funds are traded like stocks, offering:

• High liquidity—transactions during trading sessions.
• Access to global markets—U.S., Europe, emerging economies.
• Low fees—TER 0.03-0.25% annually.

Examples of ETFs include:

• Vanguard S&P 500 ETF (VOO): TER 0.03%.
• iShares Core MSCI World (IWDA): TER 0.20%.
• Tinkoff Index of the Moscow Exchange: TER 0.15%.

Minimum Investment Amount

The price of one ETF share ranges from $50 to $300. On the Moscow Exchange, some ETFs are available in lots of 10 shares (approximately $200 and up).

Dividend Reinvestment

DRIP (Dividend Reinvestment Plan) allows for the automatic reinvestment of dividends, enhancing the effect of compound interest. Many brokers offer this service at no cost.

Scenarios for Using a Passive Approach

A novice might allocate 70% of their capital to ETFs that replicate global indices and 30% to funds in local markets. This combination ensures global diversification and allows the assessment of the effectiveness of passive strategies across different segments.

Historical Examples of Passive Models

The S&P 500 index from 1980 to 2020 exhibited an average annual growth of around 10%. During the 2008 crisis, a decline of approximately 37% occurred, but by 2013, the index recovered to previous levels, and the subsequent pandemic in 2020 showcased a sharp but short-lived drop followed by strong recovery growth.

Tools for Active Management

Actively Managed Funds

Mutual funds and funds managed by professionals offer:

• Flexible asset structure changes based on market conditions.
• Potential for alpha return with successful managerial decisions.
• High fees—TER 0.5-2% and performance fees of 10-20%.
• Low transparency and reliance on the skill of the manager.

Robo-Advisors

Automated platforms (Wealthfront, Betterment, Scalable Capital, "Tinkoff Investments") use algorithms for portfolio management:

• A questionnaire to determine the investor's risk profile.
• Creation of a diversified portfolio with ETFs.
• Regular rebalancing—quarterly or semi-annually.
• Low fees—0.25-0.5% annually.
• User-friendly interface and educational materials within the app.

Case Study: Alexey from St. Petersburg utilized a robo-advisor, invested $2,000, and achieved a +12% return in the first year with minimal involvement and no emotional distractions.

Real Stories of Active Strategy Failures

Example: The largest mutual fund, XYZ Capital, exhibited an average annual return of +6% from 2010 to 2020, while a comparable S&P 500 index yielded +10%. The reason for this underperformance was high fees and poor bets on the banking sector from 2015 to 2017, leading to the fund lagging nearly 30%.

Fees, Costs, and Returns

Total Expense Ratio (TER)

The primary parameter for comparing funds and ETFs:

• Passive funds: TER 0.03-0.3%.
• Active funds: TER 0.5-2% + success fee.
• Brokerage fees: from $0-5 per trade in the U.S., from 0 to 0.5% of the amount in Russia and the EU.

The Impact of Costs on Returns

A difference of just 1% in TER annually, with an average return of 7%, can lead to a 10% reduction in total capital over 10 years. Instead of $19,671, you would receive approximately $17,659.

Hidden Costs

Besides TER and brokerage fees, there are:

• Spread when buying/selling ETFs.
• Exchange fees for clearing and settling financial instruments.
• Taxes on dividends and capital gains.

Level of Involvement and Psychology

Time and Skills of the Investor

• Passive investor: 1-2 hours per year—selecting a fund and checking the portfolio.
• Active investor: up to 5-10 hours per week—analysis, news monitoring, and trading.

Emotional Risks

Panic selling during active strategies can reduce returns by several percentage points. The passive approach helps to avoid "timing risk" but requires patience during market downturns.

Common Mistakes by Novices

• Overtrading and trying to "time" the market.
• Deviating from the strategy during the first downturn.
• Ignoring costs when selecting funds.
• Insufficient attention to tax implications.

Tax and Legal Aspects

Taxation of ETFs and Mutual Funds

• Russia: 13% personal income tax on dividends and capital gains.
• U.S./EU: dividends taxed at 15-30% for non-residents, capital gains tax up to 20%.

International Counterparts

ISA (UK): tax-free contributions up to £20,000 per year. Roth IRA (USA): "post-tax" contributions, tax-free withdrawals after holding for 5+ years. These instruments help reduce the fiscal burden on long-term investments.

Comparisons and Recommendations for Novices

Comparative Table

Step-by-Step Guide to Get Started

1. Define your goals and investment horizon.
2. Assess your risk profile using an online calculator.
3. Choose a broker with low fees and a user-friendly platform.
4. Open an account and transfer the amount for investment.
5. Allocate your capital: core—ETFs (60-80%), satellites—active instruments (20-40%).
6. Set up DRIP and automatic rebalancing.
7. Maintain an investor journal and analyze results quarterly.

Tips for Combining Strategies (“Core & Satellite”)

The core of the portfolio (Core): passive index funds for global markets. Satellites (Satellite): individual high-yield assets—growth stocks, AI sectors, ESG funds, or thematic ETFs. This approach balances stability and growth.

Expert Forecasts for 2026

• The artificial intelligence sector is expected to see a 15% annual growth in investments.
• Renewable energy is attracting new funds with yields of up to 10%.
• Geopolitical instability will increase demand for defensive assets—gold and high-quality bonds.

Passive or active investing is not a choice of "either/or" but a continuum of strategies. A novice should start with minimal fees, automation, and low involvement, and then as their skills grow, experiment with active approaches while maintaining a hybrid portfolio for maximum returns with controlled risks.