As we had learned about the inner-workings of passive investing in the previous edition, we will now focus our attention on passive management’s counterpart, active investing (active management). Under this type of investment management, managers take a more proactive approach in effort to achieve optimal returns and to outperform the market.
What is active investing and how does it work? This investment strategy uses the human touch to actively manage an investment portfolio. Managers will utilize analytical research, forecasts, as well as their own investment experience, expertise and judgment in an effort to make the best possible investment decisions regarding what securities to buy, sell or hold. Active managers tend to believe that short-term price movements are significant and that these movements can often times be predicted. They are not bound by any single index fund’s performance potential and can deploy a multitude of strategies with the goal of outperforming an investment benchmark index. Some of the strategies used by active fund managers to construct their portfolios include risk arbitrage, short positions, option writing and asset allocation.
Asset allocation may very well be the most conventional strategy. Designing an appropriate asset allocation strategy can lay the very infrastructural baseline that active fund managers and investors alike require in order to achieve superior returns (compared to that of a single index fund).
There are key advantages inherent within active management that may make it a more suitable investment style. One benefit includes the ability to be flexible with one’s investment choice. Practicing active management allows the manager and/or the investor to select different securities from different industries, sectors and asset classes. The flexible nature of active management investing supplements another major benefit; risk management.
With an active investment style, one can both increase and/or dial back their risk parameters, as investors have the ability to enter and exit specific holdings or market sectors at an opportune time. Active management can also facilitate one’s ability to manage portfolio volatility. By investing in less-risky, high-quality investments as opposed to investing in the market as a whole, investors can control and help monitor the volatility within a given investment portfolio amongst all assets classes.
It is very important to note that the cost associated with active investing tends to be higher than passive investing. Frequent trading activity will generate higher transaction costs which can ultimately diminish an investor’s returns. Managers who can add significant value to their portfolio should be in a position to outweigh the increased costs.
Before making any investment decisions, it is crucial that you first consult with a professional financial advisor who can help you determine whether or not this type of investment strategy is going to fit your current and future financial life. To learn more on active investing, be sure to check out the latest edition of the Mitlin Minute. If you’re interested to learn if active investing is the best path for you and your family, do not hesitate to give us a call. Let Mitlin Financial, Inc. help to educate you, guide you and facilitate your financial future!