Takeaways
- Active investing involves researching and continually trading stocks.
- Actively managed funds include hedge funds, family offices, and pension funds.
- Active investing can involve trading to catch momentum or catalyst events.
- Active investing positions are not as long-term as passive investing approaches.
- Actively managed funds can significantly outperform the market because they don’t simply follow an index but aim to generate a return above the market.
What Is Active Investing?
Active investing is an investment strategy that involves buying and selling investments to outperform a predetermined benchmark or market index. It is focused on beating market returns by taking advantage of short-term stock fluctuations, momentum trades, or event-driven trading to generate high investment returns.
Active investing is implemented by the world’s leading hedge funds, pension funds, and other asset managers. Their investing thesis is based on trying to beat the average return of indexes like the S&P 500 or the Dow Jones. Because active investing is much more than a simple buy-and-hold strategy, it requires ongoing research, expert real-time analysis, and constant stock market monitoring to make informed decisions about which assets need to be bought or sold.
Active investing is usually managed by small groups in family offices and hedge funds. These groups are run by professional portfolio managers who are industry, sector, or market specialists. These managers capitalize on market inefficiencies and trends to generate high investment returns.
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How Active Investing Works
Active investing combines market research, technical analysis, and the investor’s expert judgment to select investments projected to outperform the broader stock market. Active investors generally focus on various assets, including stocks, bonds, commodities, and other securities.
The biggest differentiator of active investing is the constant monitoring of investments. This involves keeping a pulse on macroeconomic conditions, like the federal funds rate and how the NYSE and Nasdaq are trading, and consistently adjusting positions based on this new information to boost fund performance.
Here’s an example of how it works: An active investor may analyze a company’s financial statements, evaluate industry and sector trends, and assess macroeconomic factors to determine whether he wants to buy a publicly traded stock.
Another active investor might rely on technical indicators, such as moving averages or momentum indicators, to time their trades with as much precision as possible. This investor probably focuses on the company across market capitalizations.
Active investing aims to maximize gains from opportunities that passive strategies may miss to achieve higher investment returns than the market average yields.
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Active vs. Passive Investing
There are two main categories of investing styles: active and passive management. Passive investing tends to generate larger returns over the long term, while actively managed funds can produce massively outside returns for their clients.[1][2] Here’s a look at the difference between the investing styles:
- Active Investing is a much more involved investing style than passive investing. Active investing tries to beat the average stock market return, while passive investing follows an index that only matches the market. As a result, active investing involves timing short-term trades to take advantage of market price movements and changes in demand and placing outsized bets on stocks, corporate bonds, or real estate investments that will outperform the market.
Actively managed funds aren’t limited to investing in stocks; they usually invest across a variety of asset classes. However, they are run by professional fund managers with specialized industry knowledge and tend to charge higher investment management fees.
- Passive Investing, also called index investing, focuses on investing in a basket of investments that mirror a particular index, such as a stock or bond index. It is very much a “set it and forget it” approach to investing, which allows funds to have a low fee structure.
Passive strategies tend to hold their investment selections for the long term and largely ignore market trends. They only reposition their investments when the index changes or there is an outsized shift to a bear market.
Advantages of Active Investing
There are many advantages to active investing that draw in billions of dollars in assets under management (AUM) worldwide. Here are why fund managers can consistently raise capital from investors to pursue active investing strategies:
- Above Market Returns: One of the primary benefits of active investing is the potential for higher-than-average market returns. With curated investment choices, trade prowess, and a pulse on the market, active investors can capitalize on short-term changes in price and market inefficiencies.
- Flexible Investment Strategy: This is a much more flexible approach to investing since it allows active investors to quickly adjust their portfolios to match changing market conditions, economic events, geopolitical impact, and even company-specific news or press releases.
- Personalize Approach: Active investors can calibrate their portfolios to meet specific financial goals, risk tolerance, or investment philosophies. This allows them to pivot their investment strategy to chase returns in value investing, growth stocks, or sector-specific opportunities.
- Portfolio Control: Active investing can be dynamic and provide investors with a sense of control. Fund managers are involved in the investment decision-making process throughout an investment's lifecycle.
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Disadvantages of Active Investing
While you can use active investing in your portfolio, there might be better strategies for beginner investors. Here are many cons of active investing to consider:
- High Fees: A main drawback is the higher cost of frequent trading. This is due to additional transaction fees, taxes, and management costs. High fees will erode overall investment returns.
- Time-Consuming: Active management requires a consistent pulse on broad economic issues, like Federal Reserve actions, which require extensive time and effort. In addition, knowing what the stock markets are doing, you also need the time to research and monitor investment performance. Creating active investment strategies can be a time suck, particularly for individual investors, even if you are a stock trader.
- Below Market Returns: There is also the risk of underperformance because while all active investors aim to outperform the market, many funds consistently fail to sustain above-market returns. Market timing, stock picking, and value inflection timing can be highly unpredictable. While funds might have a great year, the next might be underperforming. Even experienced investors, financial advisors, and fund analysts will make incorrect predictions, which can lead to investment loss.
- Emotional Rollercoaster: Active investing can be emotionally taxing because investors often react to minor, short-term market fluctuations instead of sticking with a specific long-term strategy. While active investing can be incredibly compelling on a short-term basis, on a protracted timeline, this reactive and often ephemeral approach can lead to returns below simple index investing.
Active Investing Strategies
Active investing requires a range of strategies, each created to capitalize on various market conditions and investor goals. Here are three popular methods to consider.
1. Fundamental Stock Picking
This investment approach requires a strong understanding of company fundamentals, such as financial statements, business forecasts, and competitive moats. Investors select the best individual stocks a la carte that they believe will outperform the market based on in-depth research and analysis.
2. Quantitative Trading
Quantitative investing involves building models that contain factors that fund managers believe influence stocks, sectors, or industries. While algorithms can be adjusted in real-time, they are usually deployed with pre-set configurations to capture arbitrage in markets or economic cycles.
3. Event-Driven Investing
Event-driven investing takes advantage of catalyst or value-driven events. Investors look for opportunities based on acquisitions, earnings, mergers, or product launches. Event-driven investing relies on predicting how these events will be interpreted by Wall Street and impact stock prices.
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Smart Summary
Active investing is a strategy deployed by money managers and retail investors. It relies on researching investments, keeping a pulse on macroeconomic events, and trying to earn above-market returns. In general, active investing is managed by fund managers who are highly specialized investors. While active investors, like hedge funds, can have incredibly high returns, their investors take on a significant risk of loss of principle. Weight the pros and cons of active investing to see if it makes sense.
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(1) Morningstar. Active vs. Passive Funds by Investment Category. Last Accessed January 14, 2025.
(2) Institutional Investor. The 23rd Annual Ranking of the Highest-Earning Hedge Fund Managers. Last Accessed January 14, 2025.
