Introduction
Active investing is a hands-on approach to managing an investment portfolio. Here, the investor or fund manager buys and sells regularly, intending to outperform the market. Active investing differs from a passive approach. The latter involves buying a fund that mimics the market index and requires minimal adjustment during market fluctuations.
Active investment is noted for relatively higher returns but can be full of challenges. This article discusses the complexities involved in this investment approach.
Challenges associated with active investment
1. Information overload
Market news plays a vital role in the price movement in a trading or investment. But what if you are bombarded with constant data, news, and analysis from various sources? The speed at which this information travels and the volume that needs to be processed can be challenging.
Earlier, before the digital era, investors relied on annual and quarterly reports, but now, even the smallest companies generate a continuous flow of updates. This makes decision-making a challenging task.
2. Market efficiency
The hypothetical situation of an efficient market suggests it is impossible to consistently gain higher returns than the average market on a risk-adjusted basis.
The reason is that stock prices already include all the information people know about them. Though some argue about this theory, it highlights how tricky it is for investors to find cheap stocks that the market has not spotted yet.
3. Costs
Active investing incurs higher costs than passive investing. These costs come in the form of transaction fees, taxes, and management fees. Each trade can eat into the profits, and the taxes on short-term capital gains can be significant.
Also, the fees charged by active fund managers can be high, regardless of the fund's performance.
4. Emotional bias
Investors are not immune to emotional biases that can lead to irrational decision-making. Fear and greed can compel investors to make hasty decisions, such as panic selling during a market downturn or buying into a stock at the peak of its value due to FOMO (fear of missing out).
Active investing requires discipline and the ability to detach from emotional responses to market fluctuations.
5. Time commitment
This investing approach is not a set-it-and-forget-it strategy. It requires a significant time investment to research and monitor investments. For individual investors, this means dedicating hours to stay educated about market trends, company performance, and economic indicators.
For professionals, it means a career's worth of continuous learning and staying ahead of market movements.
6. Performance pressure
Active investors trade under immense pressure. Since the benchmark is often the market index, failure to outperform them can be seen as a failure, despite the possibility that you are seeing positive returns.
This pressure can lead to over-trading or taking on unnecessary risks in an attempt to catch up with the mark. This ultimately can be detrimental to the portfolio's health.
7. Competition
Active investors compete not only against other individual investors but also against institutional investors. They also compete with algorithms that process information and execute trades much faster than humans.
Since professionals have more resources, information, and tools at their disposal, it is difficult to beat them in the market.
8. Market timing
Timing the market is an integral part of active investing. It involves predicting market movements and buying and selling stocks accordingly. However, even seasoned investors find it difficult to time the market accurately, and mistimed trades can lead to significant losses.
9. Regulatory changes
The stock and securities market is subject to regulatory changes that can impact active investing strategies. New regulations can influence the performance of any company and, if unfavourable, lead to a sharp decline in the stock price.
Also, if the regulator restricts the number of trades one can place or raises the tax rate, you may have difficulty succeeding in active trading.
10. Technological advancements
The rise of technology has changed the face of investing. High-frequency trading and sophisticated algorithms have made the markets more complex and unpredictable. As an active investor, you must adapt to these changes and invest in technology to keep up with the competition.
Conclusion
Active investing is tricky. You need to have in-depth market knowledge, be skilled and disciplined, and have resources. That is why many investors choose a passive approach. But if you are up for the challenge, active investing can pay off if you stay up-to-date with trends and avoid emotions when the market takes a downturn.
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