Active investing is an investment strategy in which the investor takes an active role in deciding which securities to buy or sell to exploit short-term price fluctuations. The investor may use various analytical tools to make these decisions, including fundamental analysis, technical analysis, or a combination of both.
Active investors typically seek to generate higher returns than those offered by passive investment strategies, such as investing in index funds. However, active investing can be a difficult strategy that’s not suited for all investors. Active investing takes time and expertise, and even professionals struggle to beat the market. Here are some more insights into active investing and whether the strategy may be right for you.
Active Investing Definition
Active investing is a strategy where an investor attempts to beat the market by trading individual stocks, bonds, or other securities.
With active investing, either an individual investor could be the one trading securities in their own portfolios, or portfolio managers of actively managed exchange-traded funds (ETFs) and mutual funds could be the one buying and selling assets to outperform the market or a specific sector.
Active investors and actively-managed funds often trade stocks and securities to profit in the short term. Short-term trading, like day trading or swing trading, can be difficult as it requires the investor to be an expert on the financial markets and the factors impacting stock prices. It also requires the investor to have a good deal of discipline, as short-term stock picking can be a volatile and risky endeavor.
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Differences from Passive Investing
Active investing is a strategy where an investor takes a more hands-on role in choosing stocks or other assets to buy and sell. The goal of active investing is to beat the market by continuously buying and selling securities, taking advantage of short-term price fluctuations.
In contrast, a passive investing strategy is when an investor buys and holds a mix of assets for an extended period. Many passive investors will invest in passively-managed index funds, which attempt to replicate the performance of a benchmark index. Passive investors are not necessarily trying to beat the market.
Active investing is generally a more hands-on and involved approach than passive investing. It requires the investor to understand the nuances of the financial markets and the factors that can impact asset prices, like technical and fundamental analysis. It also requires the investor to have a good deal of patience and discipline.
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Pros and Cons of an Active Investing Strategy
|
Pros and Cons of Active Investing |
|
|---|---|
| Pros | Cons |
| May be fun to follow the market and make your own investment decisions | Difficult to beat the market |
| Can profit in up, down, and sideways markets | Time consuming |
| Can tailor a strategy based on your goals and risk tolerance | Higher fees and commissions |
Advantages to Active Investing
Active investing has its perks. If you are in the driver’s seat when it comes to buying and selling stocks and other securities, it’s one way to build your investing chops. Rather than investing in passively-managed index funds or employing a buy-and-hold strategy, you can research individual companies, sectors, and geographies and put that knowledge to work by placing your bets.
Investing in specific companies you know and believe in can be both fascinating and rewarding, especially if they align with your interests or social values. It can also be exciting to put your skills to the test and see if they get rewarded.
Another pro of active investing is the possibility of potentially outperforming the market. If you passively invest in funds that mirror the market, such as the S&P 500, you can only do as well as the market performs. And if there’s a significant market downturn, you will likely see losses.
But if you or a fund manager put your expertise to use and actively pick stocks that do very well, there is a chance you can earn higher returns than you would otherwise passively invest in index funds.
It should be noted that most active investors, including professionals, have historically had difficulty beating the market, especially after factoring in investment fees and taxes paid.
Active investing also allows you to put in place a strategy that’s tailored to your preferences, financial goals, and risk tolerance. Whether you’re willing to be speculative because you’re young, prefer to support companies that align with your values, or want a mix of stocks that you think are the most likely to do well, active investing allows you to build a completely customized portfolio.
Disadvantages to Active Investing
While active investing has its upside, it also comes with risks and disadvantages. For instance, while an active strategy has the possibility of beating passive funds when it comes to returns, the likelihood of that happening is very low.
According to a S&P Dow Jones Indices report , about 80% of all actively managed U.S. equity funds underperformed their benchmark indices in 2021. And that’s when professional fund managers are the ones picking stocks.
The reality is that no one can precisely predict the direction of the market or an individual stock’s performance in the short term. Thus, active investing can be challenging, and there is a real risk that you will earn lower returns than you would with the passive approach.
Another downside of active investing is that it takes time. Having a chance at success as an active investor means doing a lot of research on companies and market conditions, keeping tabs on news that could affect performance, and making decisions about buying or selling.
Additionally, active investing can encourage you to focus on the short term rather than the long term. Whereas passive investors typically look at the long-term potential of their holdings, many active investment strategies are focused on near-term gains, whether weeks, days, or even minutes. If you get lucky, that short-term focus has the potential to lead to quick profits. But more often, it also creates more opportunities for losses.
A short-term focus also usually means buying and selling stock more often, which can get expensive. Trading frequently comes with added costs, from the fees you pay to trade to the adverse tax impacts, such as capital gains taxes.
If you’re saving for goals that are years away, such as retirement, or prefer less risk and lower fees, you may want to think twice before adopting an active approach.
Tips for a Successful Actively Managed Fund
You want to consider a few things before investing in an actively managed fund.
For starters, you want to have experience in the markets; the investment team of an actively managed fund should have a proven track record of outperforming the markets.
Additionally, you want a well-defined investment strategy. The strategy should be clear and easy to understand. It should be based on rigorous analysis of the markets and should be implemented with discipline. The investment team should follow strict investment rules and not be swayed by emotion.
Furthermore, risk management is critical to the success of any investment strategy. The investment team should have a clear understanding of the risks involved and should be prepared to take action to protect the fund’s capital.
Finally, you want to invest in an actively managed fund that commits to transparency. The investment team should be transparent about the fund’s holdings, performance, and fees.
Is an Active Investing Approach Right for Me?
Active investing generally isn’t appropriate for investors who want to avoid trading and research costs or who lack the expertise to perform their analysis. Instead, these investors are better off with a passive investing approach.
Passive investing is a viable option for investors who are content to accept market returns, don’t mind owning a broadly diversified portfolio of stocks or other securities, and are willing to hold their investments for the long term.
Active investing can be a good choice for investors who are willing to take on the added risk and costs of trying to beat the market. These investors should be comfortable with the idea of holding a concentrated portfolio of stocks or other securities and be prepared to actively manage their investments.
The Takeaway
Remember that deciding between active and passive investing doesn’t have to be an all-or-nothing deal. You could opt to invest some of your holdings in passive funds or with an automated investment tool while setting aside another portion to invest more actively. Diversifying your investment strategy may help you get experience in the financial markets, so you can gain the expertise and confidence to employ a larger active investment portfolio.
If you want to start active investing, SoFi Invest® can help. With a SoFi Active Investing account, you can trade stocks and ETFs with no commissions and no account minimums. Plus, you’ll get access to the latest market news and data to help you be a smarter investor – all in the SoFi app.
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