A post over at Boomer & Echo made me realize that the terms “active” and “passive” have multiple definitions when it comes to investing. This can lead to confusion.
The most technical definition of active/passive relates to investor goals for returns:
Active Investor: One who seeks to outperform the market averages. This is usually done by either attempting to make better short-term trades or by trying to choose better stocks for the long term. Most active investors fail to beat the market, but each year some succeed.
Passive Investor: One who chooses to own one or more indexes of stocks, bonds, or other assets. This type of investor usually seeks to minimize costs to get returns as close as possible to market averages.
Another definition relates to how frequently an investor makes trades.
Active Investor: One who makes frequent equity trades.
Passive Investor: One who trades equities infrequently.
A third definition relates to how involved an investor is in the business of investing his or her money.
Active Investor: One who takes a do-it-yourself approach with investing.
Passive Investor: One who hands control of his or her investments to a professional.
I am now a passive investor in the sense that I invest in broad indexes, and passive in the sense that I trade infrequently, but I’m active in the do-it-yourself sense. Warren Buffett is active in terms of stock picking and handling his own investments, but is passive in the sense of trading infrequently.
It would be nice to have everyone agree to use different terms for all these definitions, but I’m not holding my breath.