Benefits and Disadvantages of Active and Passive Investing

DMI Holdings
June 7, 2023

Understanding the key differences between these two strategies is crucial for investors to make informed decisions aligned with their investment objectives, risk tolerance, and time commitment.

Investing is an essential tool for individuals seeking to build wealth, achieve financial goals, and secure their future. Within the realm of investing, two primary approaches have emerged: active investing and passive investing. Understanding the key differences between these two strategies is crucial for investors to make informed decisions aligned with their investment objectives, risk tolerance, and time commitment. In this blog post, we will explore the fundamental disparities between active and passive investing, shedding light on the distinct approaches, benefits, and considerations associated with each.

ACTIVE INVESTING

Active investing occurs when the investor is hands-on. These investors research and identify properties that meet their objectives, and negotiate a deal with the seller. Once the deal is made, the active investor may handle management of the property as well. This could include marketing the property, handling rent payments, repairs, screening tenants, and even drawing and executing the lease.

While there are many benefits to being an active investor, the largest tend to be seen as:

Maximum control over the investment
Tax related benefits flow directly to the investor
Minimum fees are paid since there isn’t a leasing agent or property manager.

Like all things, there are also disadvantages to being an active investor:

Must have an understanding of the ins and outs of managing properties
It requires detailed knowledge of overall market, as well as growth trends and landlord-tenant laws
Large amounts of capital are tied up in the down payment of the property, which makes active investing have the least amount of liquidity
Since every investment is actively managed it is difficult to scale up and diversify a real estate portfolio.

PASSIVE INVESTING

Passive investing happens when an investor provides capital to an investment but a third-party does the majority of the work. Passive investors tend to analyze offering memos, and review regular financial and performance reports. Passive investing can be the perfect match for investors who want the benefits of owning real estate without having to manage, or own, the property.

Other benefits include:

Minimal knowledge of managing investment real estate is required
By investing capital into multiple projects, it is easier to diversify the investor’s portfolio
Easier to have access to investment properties that can be difficult for smaller investors to purchase
May have greater liquidity when investing.

The disadvantages of passive investing are more direct than the disadvantages of being an active investor. These include:

Much less control over the real estate investment
Not all tax benefits may flow directly to the investor
More overhead and fees paid to third parties who oversee the property and share the profits