An approach in investing that prioritizes activeness in buying and selling activity to maximize returns.
Active Investing Details
An active investor tries to take advantage of short-term price fluctuations to gain a profit. To do so, the investor actively buys and sells investments and regularly monitors price activity to look for openings. Active investing requires investors or traders to be highly involved. Whether it’s the foreign exchange, stock market, or any other investment field, active investors are the ones who are ready to put in many hours a day to look at price movements, with some of them treating this activity as a full-time job.
Active investors are short-term profit-seeking folks. Active investing aims to beat the market’s average return by hunting for small price changes that can net profits. Unlike passive investors who use fundamental approaches and hold their positions for a long time, active investors rely more on an analytical approach to trading. They decide when to buy or sell by looking at the movement of a price graph.
Active investors often entrust their investment portfolio to a manager. An investment portfolio is a compilation of investments owned by an individual or institution that include stocks, bonds, or other investment vehicles. A manager, or “money manager,” is a firm or a person who specializes in managing somebody else portfolio for the benefit of its client. To align the interest of both the client and the manager is to see the portfolio grow. Managers are usually paid based on the percentage of assets value under management.
Example of Active Investing
Andy is a forex trader who regularly monitors currency pairs’ price movements every week. As a swing trader, he usually holds positions lasting for a few days. Despite this, he still needs to monitor his position at least a couple of times a week to ensure that he can execute his plan well. Since Andy trades quite frequently, we can say that he is actively investing. Andy is not as active as day traders, who often hold positions for merely hours or even minutes.
Significance of Active Investing
Active investing brings its advantages and disadvantages. One of the main strengths of active investing is more significant returns. For instance, as a day trader with a $5,000 account, an experienced trader may gain an average profit of $100+ per day -- keep in mind that the actual result depends a lot on the traders’ trading strategy and experience. On the other hand, if you are a passive trader with a $5,000 account, gaining the same amount of income per day is pretty unlikely, no matter how skilled you are.
Active investing also provides flexibility. Since active traders buy or sell assets frequently, they can adjust their positions according to the market movement. This is very different from passive traders, who are usually locked into positions no matter what happens in the market. It is not because they can’t, but passive investors need to hold positions long enough according to their initial plan.
The biggest disadvantage of active investing, however, is risks. Potential gains are high, but so is the possibility of losing most, if not all, of your investments. Another weakness is cost. Lipper, a U.S. financial services firm, states that the average expense ratio for actively managed investments is 1.4 percent, compared to only 0.6 percent for passively managed investments. This is because more buying and selling activities also incur more transaction costs.
Active Investing vs. Passive Investing
Passive investing is an investment approach that tries to minimize buying and selling activity but still tries to maximize returns. If you are a passive investor, that means you need to resist the temptation to react to every move the market makes, contrary to active investors. For example, you purchase an index fund, a type of mutual fund with a portfolio made to match a market index like the Nasdaq Composite Index, and hold it for a long time, often years. For passive investors, sharp, momentary market movements (whether downward or upward) don’t matter; they will only make a move once the long-term goal is achieved.
There has always been a debate about which one is better; active investing or passive investing. Overall, passive investing is more popular than the active approach, as it’s historically proven that passive investments earned more profit than active ones. This is the case since active investing incurs more risks, which is not suitable for beginner investors who comprise the major players in the market. That said, acting investing is becoming more popular these days, especially during market fluctuations.
Whether active or passive investing is more suitable for you depends on your investment goal as well as your comfort zone. Passive investing has lower risks as well as lower fees and tax expenses. However, they don’t offer as much flexibility and generate lower returns. Meanwhile, active investing is great for those who like the challenge to get the big fishes, but it also more expensive and has bigger risks. Financial advisors generally recommend passive investing, especially for beginners, though others believe that the best strategy is to blend active and passive approaches.