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Investment funds with active managers have been thrust into the spotlight as some have significantly outpaced passively managed funds.
Active investing, in which a fund manager or investor proactively moves money into different investment vehicles, has the potential to beat the market and outperform passive funds.
The best active fund managers can double your capital in a short period.
However, many believe that active investing is unnecessarily risky and flawed in many ways.
Let’s take a look at what this approach to investing is really all about.
What Is Active Investing?
Active investing is when a fund manager or investor takes an active role in investment management.
This approach to investing emphasizes timely and strategic trades frequently to maximize profits.
Active investing aims to outpace the entire stock market and outpace gains in specific economic sectors.
The downsides to active investing includes a larger time commitment, higher levels of risk, and more fees.
>> More: Best Day Trading Platforms
How Does Active Investing Work?
Contrary to passive investment funds that are largely automated and overseen by a human, active investment funds are directly managed by a financial professional.
This fund manager actively buys and sells on behalf of client investors to outpace competing passive funds, specific sectors, and the market.
Why Is Active Investing Hard?
Active investing requires keeping one’s finger on the pulse of the stock market, the economy, specific stocks, and the political scene.
Even a slight alteration to the political landscape or the economy can have a major impact on specific stocks and sectors.
For example, new banking regulations might positively impact fintech stocks like Square (SQ) or PayPal (PYPL). Or a cyber attack could send cybersecurity stocks like CrowdStrike (CRWD) and Okta (OKTA) spiraling.
This approach to investing can be frustrating as there is considerable risk in investing more than 5% of a nest egg in individual stocks, ETFs, mutual funds, or crypto.
Not to mention the fees that rack up due to actively managing the fund; generating meaningful gains becomes that much more difficult.
Active Investing Example
Rather than strictly adhering to a market index like the S&P 500 (VOO) and attempting to match the gains of the benchmark, active investing moves money into specific stocks, ETFs, and mutual funds and then makes adjustments as necessary.
The investor in this hypothetical situation might be inclined to actively manage his investments on his own or entrust a fund manager to do so on his behalf.
Let’s assume this investor would like to invest in the gig economy while also spreading out some of his money into other economic sectors.
A comparably large percentage of the investor’s money can be directly invested into cloud computing stocks such as Amazon (AMZN), Microsoft (MSFT), and Google (GOOG) rather than an overarching tech economy ETF like the Nasdaq’s QQQ.
Pros and Cons of Active Investing
- More Control Over Portfolio: The fund manager is empowered to make trades whenever necessary, optimizing control and potential gains
- Risk Management: Proactive investing identifies and mitigates risk
- Capitalize on Short-Term Opportunities: Active fund managers make timely trades in accordance with market news, political developments, etc.
- Immediate Portfolio Adjustments: An active fund manager can instantaneously alter a portfolio for risk mitigation, increased diversification, and strategic alterations based on a wide variety of dynamics
- Riskier for Inexperienced Investors: Active management increases the risk level, meaning inexperienced investors have the potential to lose money while racking up the fees
- Higher Fees: Active management requires an investment of effort and time, so the higher fees are certainly understandable
- Hedge Funds are Selective: An investment opportunity that fails to meet specific criteria will not prove investable
Is Active Investing and Day Trading the Same Thing?
No, day trading involves rapid trades based on real-time analysis of individual stock dynamics and analysis of the market, the economy, political developments, and news stories.
Day traders trade stocks at a much higher frequency than active fund managers.
Are Hedge Funds Active Investors?
For the most part, hedge funds are actively managed. The hedge fund manager buys and sells investments in accordance with the market outlook, analysis, and other factors.
Is it Risky to Start Active Investing?
Active investing is best left to experienced investors. If you are new to investing and don’t want to take the passive investing approach, consider parking your money in a fund actively managed by a trustworthy financial professional.
Otherwise, DIY (do it yourself) active investing as a new investor might lead to a series of bad trades, high fees, wasted time, and a red portfolio.
Why Is Active Investing Not Smart for New Investors?
New investors should spend the time they devote to investing to learning about specific strategies, studying stocks, reading about the economy, and developing an understanding of trading platforms.
Beginners who jump right in as active investors tend to fail as they have not invested enough time reading about individual stocks, the economy, and investing strategies.
Tips for Active Investing
#1. Be Calm
Don’t let your emotions shape your investing decisions.
#2. Research All Opportunities
If you actively manage your investing dollars instead of relying on an active fund manager to do so, be prepared to perform some deep digging. We recommend investing resources (stock picking services) like the Motley Fool or Barron’s.
Do not invest until you have performed your due diligence.
#3. Study and Practice
Don’t start out actively investing with real money. Use fake money and “paper trade” in preparation for investing with actual money.
Bottom Line: What Is Active Investing?
Active investing is ideal for those who want an experienced and savvy fund manager to proactively capitalize on investment opportunities as they arise.
The timely acquisition and sale of stocks, mutual funds, ETFs, and other investment vehicles through active investing is considered a success when returns outpace the stock market or a specific index.