While not everyone is cut out to emotionally manage the highs and lows of the stock market, the number of people who like to take an active role in managing their money is significant. Whether it’s by using a money manager or taking a do-it-yourself approach, active investors bank on the belief that they can consistently pick opportunities that outperform the market. Active investing prioritizes short-term gains, as opposed to a traditional buy-and-hold strategy. What’s so appealing about active investing? Here’s why so many people opt for this approach.
1. Greater potential upside
Whether or not they turn out to be correct, four out of 10 investors believe they can beat the stock market by taking an active investing approach. This strategy is particularly common with millennials, 31% of whom prefer active investing — which could drive a stronger trend toward active investing in the future as millennials continue to gain increased access to wealth. While it’s true that they theoretically could beat the stock market, active investors who make poor financial choices (or just happen to be caught in the unlucky crosshairs of fate) could do worse than if they had taken a passive investing approach. The stock market is, of course, volatile. Active investors should be aware that along with a potential upside comes the potential to experience the downside of the stock market.
2. Stronger alignment with personal values
The impact investing market is estimated to be as large as $715 billion. For a growing number of investors, contributing funds to companies that can bring about social good as well as a financial upside is of heightened importance. Passive investment strategies rarely enable this, but active investors can invest in organizations that matter to them.
While having this emotional tie to investments can make people feel good about how they’re using their money, the risk is also high. Impact investing could cause people to stay committed to an investment longer than they otherwise would have, not selling even if they logically should. If you decide to move money into investments that you care deeply about, you should consider having a limit for how long you’re willing to stay if your investment starts to lose money.
3. Potentially more liquidity
Some passive investments, like a certificate of deposit, require investors to commit for a certain length of time. Other passive investments don’t technically require you to lock in for a set period, but the strategy of passive investing lends itself to staying patient and waiting for long-term gains. Sometimes, the benefits of this strategy are major, but not always. The national rate for a 60-month certificate of deposit in December 2020, for example, was 0.35%.
Active investing, on the other hand, affords investors the opportunity to move their funds regularly, taking advantage of market momentum. They can react if they see a more attractive investment or if they want to use their funds for a different purpose. In the changing and uncertain economic landscape, many investors prefer to have this level of control over their investment strategy. Keep in mind that moving funds regularly means investors can’t take advantage of the long-term benefits of compound interest. Even with a modest 6% rate of return, $1,000 can grow to $18,000 in 50 years.
4. More variety
While there are relatively few investment options for passive investors, active investors can work more variety into their portfolios, which can afford them a greater degree of sophistication. Active investors can use a combination of investment vehicles to target a certain investment return to help with savings or to create some income in retirement. Whether you want to invest in an REIT, commodities, an active business or stocks, there are many options depending on the opportunities you see and the chances you want to take.
Is active investing right for you?
Many people misunderstand their own risk tolerance when it comes to investing. For example, in 2008, the S&P 500 fell 38.49% — how would you react in such a scenario? Would you buy more stock? Sell all your stock? Sell some of your position? If you lived through the Great Recession and you already know the answer to that question, then you can probably draw on that knowledge to help you choose the best strategy for you at this point in your life. On the other hand, if you’re new to investing, you should understand how much risk you’re willing to undertake when it comes to your own money before you decide to actively invest your funds. For some people, the potential reward of participating in market swings is enough to make them turn to active investing, while others prefer to play it safe and focus on secure investments they don’t have to worry about.
Jolene Latimer has her master's in Specialized Journalism from the University of Southern California. She writes about personal finance, marketing and sports
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