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Passive investing and active investing are two contrasting strategies for putting your money to work in markets. Both gauge their success against common benchmarks like the S&P 500—but active investing generally looks to beat the benchmark whereas passive investing aims to duplicate its performance.
What Is Active Investing?
Active investing is a strategy that involves frequent trading typically with the goal of beating average index returns. It’s probably what you think of when you envision traders on Wall Street, though nowadays you can do it from the comfort of your smartphone using apps like Robinhood.
“This type of investing typically requires a high level of market analysis and expertise in order to determine the best time to buy or sell [investments],” says Kevin Dugan, investment advisor and senior partner at Dugan Brown, a financial planning firm in Dublin, Ohio.
You can do active investing yourself, or you can outsource it to professionals through actively managed mutual funds and active exchange-traded funds (ETFs). These provide you with a ready-made portfolio of hundreds of investments.
Active fund managers assess a wide range of data about every investment in their portfolios, from quantitative and qualitative data about securities to broader market and economic trends. Using that information, managers buy and sell assets to capitalize on short-term price fluctuations and keep the fund’s asset allocation on track.
Without that constant attention, it’s easy for even the most meticulously designed actively managed portfolio to fall prey to volatile market fluctuations and rack up short-term losses that may impact long-term goals.
This is why active investing is not recommended to most investors, particularly when it comes to their long-term retirement savings.
Advantages of Active Investing
- Flexibility in volatile markets. “The active investor has the potential to move to a defensive position or holding, such as cash or government bonds, during down markets to prevent catastrophic losses,” says Brian Stivers, investment adviser and founder of Stivers Financial Services in Knoxville, Tenn. Similarly, investors can also reallocate to hold more equities in growing markets. By responding to real-time market conditions, they may be able to beat the performance of market benchmarks, like the S&P 500, at least in the short term.
- Expanded trading options. Active investors can use trading strategies such as hedging with options or shorting stock to produce windfalls that increase the odds they beat market indexes. These also, however, can greatly increase the costs and risks associated with active investing, making them techniques best left to professionals and highly experienced investors.
- Tax management. A savvy financial advisor or portfolio manager can use active investing …….