When you invest, you’ll quickly come across two very different styles: passive investing and active investing. Understanding these approaches will help you decide which one feels right for you.
What Is Passive Investing? (Getting the average return)
Passive investing means buying a fund that simply follows the market. For example, a fund might track the FTSE 100 (the 100 biggest companies in the UK) or the S&P 500 (the 500 biggest in the U.S.).
- It’s simple: You don’t have to pick individual companies.
- It’s cheap: Fees are very low because no manager is “actively” choosing investments.
- It’s diversified: You get a slice of many companies at once.
This is often called “buying the market” — you’re not betting on any single company, but on the economy as a whole.
The Catch: Concentration Risks in Passive Funds
Right now, many popular market indices are heavily weighted to a handful of giant companies. For example, in the U.S., technology giants like Apple, Microsoft, Amazon, and Nvidia make up a big chunk of the S&P 500.
That means even if you think you’re buying hundreds of companies, a large part of your money is really tied up in just a few. If those companies struggle, your portfolio could take a big hit — a risk many investors don’t realise.
What Is Active Investing? (Trying to Beat the Market)
Active investing means a manager (or you, if you pick shares yourself) tries to do better than the market by choosing which companies to buy and sell.
- It aims higher: The goal is to beat the average return.
- It’s flexible: Managers can avoid areas they think are risky.
- It’s more expensive: Fees are higher, and many managers don’t outperform over time.
Imagine it like this: instead of eating every dish at the buffet, an active investor is trying to choose only the best ones. Sometimes they’re right; sometimes they aren’t.
A Useful Test: Active Share
Not all active funds are truly “active.” Some charge high fees but look very similar to the index they’re supposed to beat.
This is where the idea of Active Share comes in. It measures how different a fund is from its benchmark index:
- High Active Share: The fund is really making bold choices, quite different from the index.
- Low Active Share: The fund is hugging the index, but still charging you higher fees.
The concept was popularised by academic research from Antti Petajisto, who found that funds with genuinely high Active Share had the best chance of outperforming in the long run — but only if they were skilful.
Which Approach Should You Choose?
- If you value low cost and simplicity, passive investing is a solid option — but be aware of the hidden concentration risks.
- If you want the chance (but not the guarantee) of beating the market, active investing may appeal — but look closely at Active Share to make sure you’re not overpaying for a fund that’s really passive in disguise.
- Many people combine the two: a passive core for stability and cost, with a few active funds for specific markets or strategies.
👉 In the next article, we’ll tackle Global Funds vs Home-Bias — and why many UK investors own far too much of their home market without realising it.
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