It involves an active buying and selling activity, as well as continuous monitoring and evaluation of all relevant investment activities and information with the goal of making profits and outperforming a benchmark or index.
Investors who utilize this strategy either do all the deliverables themselves or hire a portfolio manager who would do all the pertinent investment activities on their behalf.
Pros: Advantages of Active Investing
Note that passive investing remains the most popular among investors based on its number of participants and amount of investment flows. However, there are investors and wealth managers who have promoted the benefits or advantages of active investing. Take note of the following:
• Clear Investment Goal: Remember that the purpose of active investing is to make a considerable amount of profits and outperform benchmarks or indices. The goal is straightforward: maximize the earning potential of the entire investment activity as soon as possible by actively selecting and offloading assets.
• Greater Flexibility: Individual investors or their portfolio managers are not limited to purchasing the top-performing assets or securities within a particular asset class. They have the freedom to build their investment portfolios according to their desires and following their investment goals and objectives.
• Risk Management: Note that the flexibility of this investment strategy also means that there is enough room to adjust an investment portfolio according to the prevailing trends and conditions in the relevant financial markets. This is can be an effective risk management tactic aimed at minimizing losses or reducing risk exposure.
• Tax Advantages: It is also important to highlight the fact that the flexibility in adjusting an investment portfolio or in buying and selling assets and securities can be part of a tax management strategy. An investor or his or her manager can sell losing investments to offset taxes on investments that are gaining money.
• Better Earning: The biggest advantage of active investing is its higher and faster earning potential than passive investing. Remember that the goal of this investment approach is to maximize earnings and outperform benchmarks or indices. It is somewhat similar to trading and is ideal for short-term to medium-term goals.
Cons: Disadvantages of Active Investing
Some individuals are more suitable for passive investing. The aforementioned advantages also translate to the fact that active investing is not for everyone due to its notable disadvantages and limitations. Take note of the following:
• Requires Effort: Investors who take an active and do-it-yourself approach to investing require a considerable amount of time to continuously build their expertise while monitoring and managing their investment portfolio. These investors need to be both proactive and reactive in their entire investment journey.
• Needs Confidence: Those who choose to hire portfolio managers must place a high level of trust in them. They must have the confidence that whoever is managing their portfolio knows exactly the right time to buy and sell or acquire or offload specific assets to maximize their earning potential.
• Potential Costs: Several costs are associated with active investing. These include the service fees for brokers and management fees for portfolio managers. Some managers charge a performance fee of between 10 to 20 percent of the profits. The potential for large transaction volumes can also incur repeated transaction costs.
• Minimum Investment: Minimum placement or investment is higher than passive investing. Most active pooled funds have a minimum investment threshold that would be unaffordable to most individual investors. Direct acquisition of stocks, bonds, or other securities is also more expensive than investing in passive pooled funds.
• For Aggressive Investors: Remember that active investing is not for everyone. This approach to investing is more suitable for investors with an aggressive risk profile or higher risk tolerance. The higher potential for returns translates to a higher risk, as well as a higher potential for considerable losses.
Considering an Active Approach to Investing
Active investing has strong adherents. If you are considering trying this investment strategy, you might first ask yourself pertinent questions before you start investing to determine or revisit your financial goals and objectives and evaluate your risk profile.
Of course, it is important to note that there are several instances in which passive investing has outperformed active investing. Numerous active funds and portfolio managers overseeing active investments have also failed to outperform benchmarks and indices.
Choosing between an active or a passive approach to investing is straightforward: most investors are better off choosing the passive approach while seasoned or knowledgeable investors can explore an active approach to expand their overall financial portfolio further.