What is Active Investing?

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Active Investing is a high-risk and high-return strategy though passive investingPassive InvestingPassive investing is a strategy used by investors to maximize their returns by avoiding frequent portfolio churning by buying and selling securities and instead buying and holding a diverse range of securities.read more is a low-risk and reasonable-return strategy. Unlike active investing, passive investing is a “buy and holdBuy And HoldThe term “buy and hold” refers to an investor’s investment strategy in which they hold securities for a long period of time, ignoring the ups and downs in market price during a short period of time.read more” investment strategy which aims at making long-term profits. Moreover, passive investing focuses on matching the returns with the index rather than outperforming it.

Active Investing Explained

Active investing requires constant monitoring of market conditions before making the buy and sell decisions. This implies that the investment manager or the investor needs to watch the movement of security prices throughout the day.

Key Takeaways

  • Active investing aims to earn short-term profits by outperforming the benchmark indices. It involves swing trading strategies wherein multiple buying and selling transactions are carried out in a short span of time.Active investment managers constantly monitor the stock prices throughout the day. Their goal is to benefit from price changes.Active investing is different from passive investing which is a “buy and hold” investment strategy. Passive investing is less risky, less costly, and yields moderate returns.Active investing requires qualitative and quantitative analysis before making decisions. The fund managers identify the right time to buy and sell securities.

Active investors follow the given strategies:

  • They use a well-calculated and quantifiable approach to identify the entry and exit points for each investment. This implies that an in-depth analysis of each investment is conducted before decision-making. Such analysis involves numerous metrics for evaluating a security rather than relying on just one or two factors.They avail the services of portfolio managersPortfolio ManagersA portfolio manager is a financial market expert who strategically designs investment portfolios.read more and research analystsResearch AnalystsResearch analyst is a profession where the main task includes research on specific fields, analyzing the facts and figures, interpreting the analysis, and finally presenting the same to a structured audience that can relate to marketing, finance, operations.read more to earn higher returns than the benchmark indices like S&P 500, Dow Jones Industrial Average, NASDAQ Composite, etc.They take advantage of the emerging opportunities and respond to the changing market conditions actively. No investment is undertaken based on emotions or the historical performance of the security.They believe in following swing trading strategies. Such strategies focus on generating wealthWealthWealth refers to the overall value of assets, including tangible, intangible, and financial, accumulated by an individual, business, organization, or nation.read more by holding a security for a few days or a few weeks. Swing traders profit from the changing prices of a security. If swing trading is carried on consistently, it returns large gains on investments.They customize portfolios to meet their goal of generating wealth in a short period of time. A portfolio is built based on the investor’s risk toleranceRisk ToleranceRisk tolerance is the investors’ potential and willingness to bear the uncertainties associated with their investment portfolios. It is influenced by multiple individual constraints like the investor’s age, income, investment objective, responsibilities and financial condition.read more and investment objective.They incur additional expenses (like commission) as the number of trading transactions carried out in a day is too large. Moreover, a hefty fee has to be paid to fund managersFund ManagersA fund manager refers to an investment professional responsible for fund investment strategy formulation and implementation. They collect and invest the money from various investors and create a good variety of managed funds catering to the diverse preferences exhibited by the investors. read more and research analysts. This is the reason active investing is costlier than passive investing.

Active investing is highly volatile (or risky) as the stock market changes with every small or big change in the economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more. This is the reason this type of investing is not recommended when constant returns are required over a longer period. For instance, active investing is not suitable for arranging funds for retirement. Instead, a savings plan or fixed deposit would be a better option for such a purpose.

Example

In May 2022, Morningstar Direct, an investment analysis firm, claimed that the holdings of passive retail investors have exceeded those of active investors. Precisely, as of March 31, 2022, passive investors hold $8.53 trillion in mutual fundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more, while active investors hold $8.34 trillion in active investments. The reasons active investments could not outperform passive investments are stated as follows:

  • The foremost reason is the high fees and costs. The fees of passive investing is 0.43% lesser than that of active investing. This percentage can help save trillions of dollars when the investments are huge. This is the reason passive investors saved $38.6 billion in fees.Another reason is that the initial annual costs incurred for owning index funds have been much lower than that of active investments. For instance, the exchange-traded fundExchange-traded FundAn exchange-traded fund (ETF) is a security that contains many types of securities such as bonds, stocks, commodities, and so on, and that trades on the exchange like a stock, with the price fluctuating many times throughout the day when the exchange-traded fund is bought and sold on the exchange.read more (ETF) of Vanguard 500 costs only 0.03%, which was earlier 0.20%. The initial purchasing costs have declined to meet the low-cost offerings of the competitors.Active investing lags behind passive investing because, for several years, the active investments have underperformed the benchmark indices. For instance, 85.1% of active large-cap investments underperformed the S&P 500 in 2021. This low performance of active investments has pressurized the active investment managers to make improvements in their strategies.

Despite the good performance of passive investing over active investing, one cannot guarantee success, especially in the current times of the pandemic (Covid-19).

Active Investing vs Passive Investing

The differences between active and passive investing are as follows:

This article has been a guide to Active Investing. Here, we explain the strategies of active investing along with examples and its differences from passive investing. You can learn more from the following articles –

Passive investing is preferred over active investing due to the following reasons:– The trading volume is lower in passive investing. Consequently, the expenses incurred on trades are also low.– The charges and the fees of the fund manager are almost absent. This is because passive investing need not necessarily require the expertise of fund managers.– The passive investor need not spend efforts on monitoring stock prices consistently. Short-term price fluctuations are not captured since the goal is to make profits in the long run.– The risk of investing in passive funds is lower. One can earn reasonable returns by bearing lower risks than active investing.

Active investing is preferred over passive investing for the following reasons:– It can bring in higher returns though they come with high risks and high costs.– This type of investing is flexible and gives good opportunities to chase high returns in the stock market.– The active investing fund managers can diversify their mix of assets and focus on the most promising investment. Skilled managers can make a lot of money with AI.

Active investing can beat the market index at times but not always. Therefore, even if it is performing well in the current scenario, there is no guarantee that it will keep beating the index in the future as well. Moreover, active investing need not work well in all kinds of markets (like a developing economy) and all phases of an economy (like a recession).For this reason, most of the times, the investment experts suggest following a blend of active and passive investing strategies. One must invest based on the risk tolerance, goal of investment, availability of dedicated funds, age of the investor, etc.

  • Contrarian InvestingFactor InvestingIndex Investing