Passive vs. Active Investments

I don’t know about you, but I love ice cream and gelato. There are so many flavors, and they are all so tasty! In the summer when it’s hot, a mango or lemon gelato is what I want. But as the autumn weather cools things down and the leaves begin to drop, a more savory ice cream flavor such as chocolate caramel swirl is more up my alley.

Investing can be like that, too – there are so many different choices that it can make your head spin, and your mood or station in life matters when making a selection. So, how do you decide?

You can start by knowing the differences between investment styles. There are two broad categories of investments – active and passive. And, there is just one factor I look at when I differentiate between investment styles – TIME!

You can always make more money, but time is the one thing we can’t get back. To me, if a style of investing takes time away from you and your family, then it is active. If it doesn’t, then it is passive.

In reality there is a spectrum, so we are actually going to use four categories: Mostly Active, Moderately Active, Moderately Passive, and Mostly Passive. There are plenty of other investment styles that I won’t categorize here (REITs, real estate crowdfunding, cryptocurrency, etc.). There are various categories of investing.

Highly Active

Day Trading Stocks

This is the buying and selling of securities on the same day, often online, on the basis of small, short-term fluctuations. This can be highly lucrative with a ton of risk. Prepare to spend a ton of time on education and in front of a computer screen making trades. Data shows that only around 1% of day traders are actually profitable. I hesitated putting this in at all because it is often closer to speculation than investing, but I thought it better not to ignore it as an option, albeit an incredibly risky one.

Options Trading

An option is a contract that allows (but doesn’t require) an investor to buy or sell an underlying security, ETF, or even index at a predetermined price over a certain period of time. Think of them as insurance for stocks. Buying and selling options is done on the options market, which trades contracts based on securities. While the underlying principles are quite learnable, it does take a lot of education to learn the various strategies, and near-daily attention while you are actually investing. It is completely possible to trounce traditional stock market returns, depending on an individual’s experience level and strategy.

Fix and Flipping Rental Property

This is the process of finding undervalued properties, putting in active labor to repair and update homes (whether through hard labor or managing contractors), and selling the home for a profit. This was popularized after the 2008 recession with many HGTV shows. This normally requires a lot of time from an investor; the more homes you flip, the more time you spend, and the more you stand to profit. Results can be outstanding for the experienced investor, reaching upwards of 40-50% return on investment per flip.

Side Hustle/Multi-Level Marketing/Running a Side Business

I’ve lumped these together because many folks treat these as investments. Having a Plan B can be important if all of your income comes from one place of employment. However, these options may require start-up capital and/or recurring costs. It can takes a lot of effort and large chunks of time to make a serious profit, so it is important to choose something you actually enjoy doing. This could move to the Moderately Active category, depending on the activity you ultimately choose.

Moderately Active

Managing Your Own Stock Portfolio (Individual Stocks)

More and more people are taking control of their own finances and breaking away from financial advisory firms. Trading individual stocks is a great way to build wealth, but parsing through the hundreds of companies to find the ones you want to add to a portfolio can be time-consuming. It also takes time to learn how to properly analyze and research individual companies. This is a high-risk form of investing since it is challenging to build a diverse portfolio strictly through individual stocks and securities, and the returns can be volatile.

Buying and Self-Managing Rental Properties

Many people who venture into real estate start here. They find a single family home, apartment, or condo, purchase it, put a bit of money in, and then rent it out. It sounds simple, but remember the time factor here. It is easy to spend time searching the web for a great deal, or at Home Depot looking at paint colors, or ripping up carpet after a tenant leaves. Not to mention attending to a late night call because of a toilet overflow. In truth, this can be moderately active-to-passive, depending on your level of handiness, number of units, and management systems in place.

General Partner in Apartment Syndication

General partners are the active partners in an apartment syndication. They handle the management of the business, which means they oversee acquisitions, investor management, asset and property management, and marketing. However, these tasks are normally spread out over a group of partners, so they are divided up according to expertise. This creates a wide variance in time spent among the partners. Returns on investment can be much higher than passively investing in syndications, but there’s a time sacrifice to consider.

Moderately Passive

Managing Your Own Stock Portfolio (Mixed)

As mentioned above, many people are managing their own portfolios. One of the common methods is having a core 80-90% in an index fund or ETF tracking a blended index of stocks (such as the S&P 500 or Nasdaq), with 10-20% in individual stocks. This spreads risk out over the wider market and makes daily management easier since most deposits go straight to the index fund. The other 10-20% is exploration for the individual, who is likely dabbling in individual stocks as a way to potentially boost overall returns. This is a medium-risk proposition, with the potential for returns over 12% per year.

Owning Turnkey Rental Properties

Turnkey rental properties can be a wonderful thing for an investor who wants to get into real estate without the hassle of fixing up a home or handling day-to-day management. A turnkey provider takes care of the heavy lifting, or at least that is what is supposed to happen. But you still have to go through the bank lending process with each property you purchase, and you have to stay on top of property management as well as any repairs that need to happen with the property. Once you have scaled and you know you have excellent team members, this can possibly move to the Highly Passive category.

Highly Passive

Stock Portfolio (Managed by Financial Advisor)

If you’ve decided to hire a financial advisor to handle your investment portfolio, you are effectively trading money in additional fees for your time. No matter if they actively or passively manage your portfolio, you are not involved in the day-to-day decisions. Returns are largely based on the strategy that you and your advisor settle upon; you can employ a low-risk/low-return strategy or high-risk/high-return, based on your comfort level and stage in life. Yearly or quarterly check-ins are important to ensure that you are both on the same page, as are reading monthly statements. Otherwise, you don’t really have to spend time researching investments.

Managing Your Own Stock Portfolio (Index Funds)

You have designed your portfolio to mirror the market through the use of index funds, ETFs, or target retirement funds. You deposits go automatically to the purchase of more index shares, and you don’t plan to look at your account much at all. Being subject to the volatility of the stock market makes this at least a medium-risk investment and dividends are not traditionally high (1-2% yearly), but the returns are historically 8-12% per year, depending on your funds. As they say in the financial independence (FI) community: “VTSAX and relax!”

Limited Partner in Apartment Syndication

Limited Partners pool their finances together to purchase a multifamily property along with the General Partners, who actively manage the business. Once you have vetted sponsors and selected a deal, you wire funds to the GPs who take it from there. Within 3-6 months, you begin receiving monthly or quarterly distributions (6-8% yearly), as well as updates on the property. Initially, you must educate yourself on how to vet sponsors and analyze deals, but the time commitment is minimal from there. This is the ultimate in passive investing, with relatively low risk, steady dividends, and high returns of 14% or more per year.

Alternative Investments (ATM Funds, Self-Storage Funds, etc.)

There are a ton of different ways to invest outside of the traditional stock market. There are ATM funds, Self-Storage funds, Litigation funds, Note Investments, and Small Business start-ups. All of these carry varying degrees of risk with most settling in the medium-to-high range, but the returns can be quite high, even surpassing that of apartment syndications. Keep in mind that there is an education threshold (ie. time commitment) to reach prior to investing in any of these endeavors.

One thing you may have noticed is that the level of activity or passivity required for an investment is not necessarily equal to its inherent risk or return profile. Some of the most active investments are high-risk, volatile-reward propositions, and many of the passive investments can provide high returns with much lower risk. And some of the active investments don’t return much on their time or capital investment. It can be all too easy to find yourself in a situation where you are just spinning your wheels.