Active investing refers to an investment strategy that involves buying and selling securities such as stocks, bonds, and ETFs frequently in an attempt to achieve better returns than can be achieved by simply buying and holding these investments for a prolonged period of time.
The approach requires that an investor pay close attention to market conditions to try to identify and take advantage of profitable opportunities. The typical active investor hopes to beat the market rather than simply match its performance.
To accomplish this, they are willing to trade frequently to attempt to take advantage of quick spikes in securities prices by selling their holdings when these occur. While this is extremely difficult to do consistently, many investors nevertheless employ the approach in the hope that they will beat the odds stacked against them.
Investors using this approach typically rely on various analytical frameworks to help them identify trends relating to an individual stock or market. These include:
- Fundamental analysis: This approach seeks to identify stocks that are undervalued by analyzing company cash flows and ratios such as earnings per share (EPS), price earnings (PE) ratio, book value, and more
- Technical analysis: “Technicians” look at past trading data to try and find patterns that they can use to help predict future price movements.
- Sentiment analysis: This approach seeks to use indicators which measure how investors feel about a stock, sector or market as a whole to provide clues about how those investments are likely to perform in the future.
While active investing aims to outperform the market, when transaction fees and subjectivity errors are considered, many money managers have had trouble beating their benchmark over significant periods of time. Because of this, using this approach, whether you manage your money yourself or hire an investment advisor to do it for you, can result in investment performance inferior to that of a passive investing approach. 93% of actively managed U.S. based equity funds performed worse than the benchmark they tracked between 2013 and 2016, according the to the 2016 SPIVA US Scorecard.
Active investing also typically requires a more significant time investment than passive investing. Thus, if you are managing your investments yourself, when calculating the cost of actively managing your money, you should consider the amount of time needed to research, monitor investments, and make trades.