Passive Management of Investments - Essay Example

Active investors try to apply their intelligence in the pursuit of arriving at the best deals in the financial market. Active management always attempts to select attractive areas of investment. They decide the ripe time to join and enter markets, sectors, and places of leverage in the market. Their point is to make profits and always aspire to do more than they could be doing.

Passive management of investments does not attempt to differentiate between unattractive and attractive securities or keep tabs on the markets. They invest in wide sectors that are called indexes. The aim is also to make profits (Bernstein 2001). But due to the nature of the market, they accept average returns. They diversify their investments. Active management of shares is quite appealing on paper. But it is substantially costly and surrounded by decreasing returns when compared to passive investment.
Given the unpredictability of markets and economies, it is better to diversify the risks rather than put one’s investment in one company or market. Some people can make accurate predictions on investment returns, but this may not always be the case. If the predictions are right, the returns are also abundant. In case of a misjudgment, the losses incurred could be quite severe.

The future security prices are equally unpredictable. As a result, it is difficult to predict their future. Based on this, a passive investor who spreads the risk is better-taken care of. If one can predict rightly, then the returns are always good.
The risks and returns are correlated. This is the major positive side of active investing. The high potential returns are always risky to venture in. A risk in investment is the potential to lose on the investment. Passive investment spreads the risks by diversifying the investment areas, hence a reduced risk overly.
Active management is a great deal more expensive than passive one. Active investors must incur costs to match the returns of the normally passive investor. The costs include management fees, trading expenses, market impact fees, commissions, and other taxes. On the converse, the passive investor’s index is approximately zero point five percent in a year. The wrap fee in the active investment case ranges from two to nine percent (Evanson Asset Management 2009).
From the above comparison between active and passive investors, I agree that Buffet is correct in his statement. As far as the chance to amass huge returns exists; the active investor has more fees to incur and stands a big risk to make losses on the investments. The fact that Buffet is an active investor in Berkshire Hathaway and has witnessed a reasonable return cannot blind any potential investor to the needs of active investment.
The implication of this situation is not to discourage active investment but rather to call for caution while investing. This paper does not in any way dissuade people from engaging in investment as active investors. It only presents a case in support of passive investment ahead of active one.