What is active investing?

In my last post, I discussed what passive investing was. For this post, I will review what active investing is. An active investment strategy is the opposite of passive investing since the goal is to beat the market or benchmark.

Strategy Overview

An active investment strategy focuses on selecting or creating a portfolio of investments that will beat the performance of an equivalent benchmark or market index.

Active strategies fall into two categories; top-down or bottom-up approach. A top-down approach starts by looking at the overall economy for opportunities, while a bottom-up approach focuses on a particular stock or sector for opportunities .

An active strategy can be for both equity and debt securities.

Why pick an active investment strategy?

Investors who use an active investment strategy believes the markets are not efficient on their own. They believe the price of an asset doesn’t always reflect all information available, therefore, there are opportunities to generate greater returns by investing additional resources to know more. This is opposite to what a passive investor believes, which is that markets operate efficiently. An active investor doesn’t simply buy all the stocks trading on the TSX, rather they buy the best group of stocks they believe will likely generate a greater return than if he or she had simply bought the entire index.

Another less admitted reason for picking this strategy is it fulfills our need to be right and on some level our competitive nature as humans. I’m not saying everyone using an active strategy is looking to be right, but an active strategy is a sport and for too many investors don’t even have the right gear to participate.

What are the advantages and disadvantages of active investing?

Here are some advantages with active investing:

  • Possible to beat the benchmark index
  • Direct control over investment being selected
  • More investment strategies to select from

Here are some disadvantages associated with active investing:

  • Greater trading cost
  • Higher fees than passive investing
  • Investment return is based entirely on the skills and ability of the investor
  • Beating the market consistently can be difficult over long period

An investor who uses an active strategy may generate a greater return relative to the benchmark index. The investor achieves this through an in-depth analysis to try and find an edge about a stock. The most common way to access an active strategy is through mutual funds or by investing on your own through a brokage account. Fees associated with an active strategy are generally higher than a passive strategy. However, higher fees might be justified if the returns are high enough to offset the cost while still beating the benchmark or market index.

If you believe you can beat the market or would like to beat the market, an active strategy is the way to go. But be warned, beating the market this is easier said than done.