Active investing refers to an investment strategy that involves ongoing buying and selling activity by the investor. Active investors purchase investments and continuously monitor their activity to exploit profitable conditions.
Breaking Down Active Investing
Active investing is highly involved. Unlike passive investors, who invest in a stock when they believe in its potential for long-term appreciation, active investors typically look at the price movements of their stocks many times a day. Usually, active investors are seeking short-term profits. Smart beta exchange-traded funds are a cost-effective way for investors to take advantage of active investing by considering alternative factors as opposed to simply tracking a benchmark index, such as selecting a portfolio based on company earnings or some other fundamental approach.
Benefits of Active Investing
- Risk management: Active investing allows money managers to adjust investors’ portfolios to align with prevailing market conditions. For example, during the height of the 2008 financial crisis, investment managers could have adjusted portfolio exposure to the financial sector to reduce their clients’ risk in the market.
- Short-term opportunities: Investors can use active investing to take advantage of short-term trading opportunities. Traders can use swing trading strategies to trade market ranges or take advantage of the momentum. Positions in swing trades are typically held between two and six days but may last as long as two weeks. Stock prices oscillate for the majority of the time which creates many short-term trading opportunities.
- Outcomes: Active investing allows money managers to meet the specific needs of their clients, such as providing diversification, retirement income or a targeted investment return. For instance, a hedge fund manager might use an active long/short strategy in an attempt to deliver an absolute return that does not compare to a benchmark or other measure.
Limitations of Active Investing
- Cost: Active investing can be costly due to the potential for numerous transactions. If an investor is continually buying and selling stocks, commissions may significantly impact the overall investment return. Investors who invest with an active investment manager, such as a hedge fund, typically have to pay a management fee, regardless of how successfully the fund performs. Active management fees can range from 0.10% to over 2% of assets under management (AUM). Active money managers may also charge a performance fee between 10% and 20% of the profit they generate.
- Minimum investment amounts: Active funds often set minimum investment thresholds for prospective investors. For example, a hedge fund might require new investors to make a starting investment of $250,000.