Active and passive investing are two different approaches to making money through investments. Do you know the differences between them? Do you know which is the best fit for you and your lifestyle? Let’s take a closer look.
Active investing is a hands-on approach to investing where you, as the individual investor, take a hands-on role in creating value. Typically, active investments involve limited-time opportunities that require intense daily focus in order to make money on them.
A home flipper who does their own renovations is an example of an active investor because they buy, remodel, and sell the house using their own real estate knowledge and their own two hands. If they choose to rent out the house, they become a landlord – another type of active investor – and take phone calls at all hours of the day, handling tenant needs.
Some stock market investors are active investors, pivoting in and out of hot stocks in order to try to turn a fast short-term profit. They read the market reports and are constantly online making moment-by-moment decisions. It’s stressful, but it can be effective if you love high-stress decision-making and have a knack for precise timing.
Active investing requires a high degree of risk tolerance and a willingness to make fast decisions about your investments to avoid missing opportunities at the moments they arise. The key to active investing is being right more often than you’re wrong, while you keep a constant watchful eye on your investments day after day and hour after hour.
In real estate, active investing means you are finding the properties, negotiating with brokers and sellers, interviewing the property management companies, ensuring your business plan is moving through the proper stages, and running calculations to ensure the financial details of your investment stay on track. It’s a lot to handle, but active investing can deliver a high reward if you’re willing to put in the hours.
Passive investing involves minimal day to day work and is more of a long-haul approach to making money. Although it requires patience, it requires less of a time commitment than active investment.
As a passive investor, you invest in the expertise of your sponsor and the power of your sponsor group. The passive investor provides an initial influx of money and receives ongoing updates, and later receives disbursements of money, but does not take a hands-on role in the investment. Your sponsor handles the details of your investment.
In real estate syndication, a sponsor manages a real estate project using their extensive financial and real estate knowledge. They also hire people to manage the ongoing details of the project, like tenant-landlord relations. After selecting a sponsor to partner with, the passive investor avoids any type of daily drama like taking tenant phone calls throughout the night or making decisions about repairs.
Now let’s compare and contrast some of the key characteristics of active and passive investing. As you read through this information, consider which type seems to be a better fit for you.
Active investing requires you to be an active participant in the investment and keep up to date on the little ins-and-outs of the market and your projects. This takes a huge amount of time and isn’t always a possibility for someone who has other time-intensive obligations like family, a job, or running a business.
Passive investing is a far less time-intensive approach. Your only time demands are having an initial meeting with your sponsor, choosing a project to join, and receiving periodic investment updates which typically occur quarterly.
Focus and attention
An active investment needs your full focus and attention most of the time. You must keep paying attention every moment or you could lose out on seeing key decision-points that allow you to make money.
Passive investing means you keep your eye on the prize and focus on a much bigger win in the future. It doesn’t require your daily focus, so you can keep your attention on your family, job, hobbies, vacations, and other things.
How is your tolerance for stress? Some people find the stress of active investing to be overwhelming, because it requires constant hands-on involvement. Others do not have the patience for passive investing, because it requires you to take a delayed-gratification approach.
Type of gains
Fans of active investing often feel that the gains on passive investing are too small. An active investor might be looking to double their money within a month, but they’re willing to put in hours and hours of work to make it happen.
A passive investor might think their actively-investing friend is working way too hard for their money. They let their sponsor handle the details, perhaps seeing an investor preferred return of 8% and an investor average return of 21% over a period of years, like this example from the Colorado Springs area.
Level of investment and tax impact
The level of monetary investment is also something to consider. Passive investing usually allows a much smaller financial investment, because the point is to allow it to grow over time and/or gather with a group of people to make a bigger long-term gain. Active investing usually involves a much more costly up-front investment plus continuous infusions of money.
Many experts advise spending 90% of your investment capital on passive investing, because it is safe and reliable, and putting 10% of your investment capital in active investing, because it is riskier but could possibly yield a high reward. Of course, always consult a qualified financial advisor before making any investment.
Consider the tax impact too. Passive investing does not typically involve a large capital gains tax in a single year, while active investing can result in a large capital gains tax all in one year.
Making a Decision Between Active and Passive Investing
After reading this information about the differences between active and passive investing, do you feel better prepared to make an investment? If you’d like to do some additional research, please click the button below to download our free Guide to Passively Investing in Commercial Real Estate.
We also invite you to listen to the Real Estate Syndication Show podcast, which is full of helpful information about passive investing. When you’re ready to start your personal investment journey, contact Life Bridge Capital.