Now that you know where you want to open your investment account, the next step is knowing what kind of investor you are going to be. Although there are many variations and a lot of nuance here, investing personalities are generally broken into two categories: Passive and Active. We'll dive deeper into each personality and will elaborate on what to consider when deciding which you want to be.
TLDR: Passive Investing is being okay with giving up control for consistency, you don’t mind letting another human or an algorithm decide what’s best for your portfolio. Active investing is being okay with risk and doing your own research and making your own decisions on what to buy and sell, and when to do it.
Passive investors will prefer stability over returns and don’t mind not being in control of what is in their portfolios. This is done by buying index funds and using robo-advisors. Index funds are a type of investment product that are constructed to match or track the components of a market index. One share of the index fund is built out of shares from every company in that index. Two common indices are the S&P 500, which includes the top 500 publicly traded companies in the US, and the Dow Jones Industrial Average, which includes the 30 largest publicly traded US companies. An index fund that you can buy shares of would be Vanguards VOO, which is one product that tracks the entire S&P 500 index. So you can buy one product, one share of VOO, and own a piece of all 500 companies.
Robo-advisors use algorithms and software to automatically manage a portfolio of investments on behalf of the investor. These services could have portfolios prebuilt and will distribute the money you put into different products decided by those preset plans. An example of this is Acorns which has you make two decisions: how much do you want to invest and what portfolio you want - conservative or aggressive? Conservative being cautious about losing money, and aggressive being more risk tolerant and wanting bigger rewards. Every time you deposit money into your Acorns account, their program does the rest and you don’t have to manage a thing.
Active investors will take on more risk in an attempt to achieve higher returns and control over their portfolios. Keep in mind that being an active investor may seem similar to being a day trader, but there are differences. Typically trading depends on short term speculation while active investing can still maintain a goal that takes a few years. Being an active investor doesn’t mean you’re day trading, it is a personality where you feel comfortable making the calls on what is bought or sold. Active investors will do their own research or use the services of a financial professional to make investment decisions. As an active investor you are buying and selling securities you believe will bring the returns you want on the timeline you want them. This is where the speculation aspect of trading can bleed in. At the end of the day if you’re not doing the research, you are most likely guessing. A risk of being an active investor is the temptation to buy and sell as a reaction, instead of buying and selling as part of a plan. Oftentimes companies will set limits on day trades you can make in a week; most limits are five day trades in a five day period. Being an active investor may seem like an exciting way to invest, but you leave a lot of your success up to chance. Although there are many technical tools, services, and advice that brag about high returns, at the end of the day no one know what the markets will do tomorrow. Ultimately, active investing allows you trade steadiness (that is as steady as the current market offers) for control of your decisions.
What type of investor you want to be will have a significant impact on your returns and peace of mind. Ask yourself “what would bring me more peace of mind, control or consistency?” At the end of the day no amount of money is worth your peace of mind and sleep, so be very honest with what would work best for you. Knowing this will help you build wealth in any market, good luck and go earn!
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