An active investing strategy pursues frequent buying and selling. Why investing in stocks and funds on your own may help you build wealth in the market.
As tempting as it might be to cash out every paycheck and stuff the extra
money in your mattress, that's not the optimal wealth-building strategy.
Neither is buying an expensive watch, a boat, or a fancy home theater system.
This, of course, is the premise of the widely-regarded book "The Millionaire Next Door". Putting your money to work for
you—letting your money make more money—can produce great gains over
time.
Programs such as the MyRA savings account and
employer-run 401(k)s are popular because they help wage earners put their money
to work by investing in some of the best businesses in the world.
Active investing is a trading strategy of buying and selling stocks in the
market frequently. It's often defined in contrast to passive investing, where there's little
analysis of individual stocks and only the occasional research into
low-overhead funds.
Active investing is often marked by several criteria:
Looking for inefficiencies in the price of individual stocks and tradeable securities
Buying and selling more frequently than a passive investor's set schedule
Researching the performance of securities and/or their underlying businesses
While this approach requires more work and activity than simple index fund investing, it doesn't have
to be the stereotypical, all-consuming day trading. You could spend as little
as a couple of hours a month managing your investments.
Advantages of Active Investing
Perhaps the strongest advantage of active investing is that it puts you
directly in control of your investments. Rather than relying on a professional
fund manager to decide what to buy and sell (and when!), you make all the
choices. This goes even further than passive investing; you're not beholden to
the people who decide which stocks make up the S&P 500 or Russell 2000
indexes, for example.
Finally, you can spend as much or as little time as you like managing your
investments. If you follow the value
investing approach, you may make one or two trades every year for several
years and then a handful of trades in a couple of months, depending on your
goals and market conditions. The more you know, the more you'll be rewarded,
but you can find bargains with a little research and a lot of patience.
Disadvantages of Active Investing
The more frequently you trade, the more you have to understand about
transaction costs and the tax implications of your trades. You don't have to be
a day trader, but you should understand the broad perspective of long-term
versus short-term capital gains and which types of investment accounts you're
working with.
Unlike the "set it and forget it" system of passive index fund investing,
you need to look at price targets. Maybe you're waiting for a stock under
pressure to dip to the point where it's a bargain. Maybe you've found a
turnaround play that'll hit a threshold at which you want to sell it. You need
to have a strategy and pay attention.
Finally, there are a lot of options for your money. You could analyze tens
of thousands of stocks without even dipping your toe in the ETF market or
looking at REITs or bonds or derivatives or options. Obviously you need to
narrow the field somehow, but with a little bit of guidance, you can find
sufficient opportunities of interest without chasing down every possible
lead.
Should Value Investors Practice Active Investing?
The question almost answers itself. If, as value investors believe, the
market occasionally has inefficiencies where the current price of stocks may
not truly reflect the underlying value of the business, you'll have the
opportunity to buy great businesses at good prices. Whether you hold them
forever (a passive-active investment strategy) or hold them until they've made
sufficient money that you prefer to invest it in other undervalued businesses
(an active-active strategy), value investing works when you look for ways to
make your money work for you.
There's no strict schedule; you can be a fantastic value investor making the
right trade only once a decade, if you want. By committing to educating
yourself about good stocks and looking for bargains, you've already taken an
important step toward managing your own money and putting it to work as you see
fit.
