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30th May 2019 | Flawiusz Pawluk | Financial Markets Expert

Pros and cons of active investing

Active investing is an investment strategy that involves actively buying and selling (managing) assets by the portfolio manager, with the intention of making profits that outperform a benchmark or index.

Key pros – why investors like active investing

  • The possibility of beating the market – it is possible (however not very likely) that in a single year actively managed investment strategies will beat the performance of main indexes. Active managers believe that they can beat the market by predicting trends and investing in hand-picked stocks. When they are right, their insight translates into huge returns, which would not be possible if you were following a passive strategy.
  • Flexibility - active portfolio managers have a better chance to build the investment strategy which better reflects the needs of the particular individual investor, whereas passive managers may be tied to a particular index or sector represented by a relevant ETF. 
  • Tax efficiency – actively managed investment products may be built in a way to fully utilize any potential tax breaks or tax preferences.

Key cons – why passive investing is not a perfect solution

  • Human error – placing your trust in an investment manager, you have to accept the possibility that he or she can make a mistake. They could choose a bad stock and potentially wipe a lot of value off your portfolio in the process, even if the general market trend is positive.
  • High cost – actively managed funds have notoriously high fees, which are typically in the range of over 1.2% annually. This could potentially mean that over the 10 years period, management fees may eat up to 40% of the potential profits. 
  • Poor performance in the long term – it is very unlikely that in the long term (10 years or more) actively managed strategies will be able to beat the performance of the main indexes, even if the management costs are reduced. Apart from the human error risk, you have a risk of overtrading as active portfolio managers tend to trade more than passive, generating some unnecessary trading costs.

Conclusions

Active investing has lost its shine during last few years despite the market prosperity. Even though they have been very popular in the past, hedge funds and algorithmic trading have not been able to beat passive investing. Subsequently, active fund managers have been forced to significantly reduce their management fees as they were unable to deliver any added value for investors. However, active investing has kept one of its biggest advantages – higher flexibility in building customized investment products. Subsequently, we expect that this type of investing will be still present on the market, however, with diminished value of assets under management (AuM).

All Investment products are at risk, as their value can go down as well as up. The tax treatment of your investment will depend on your individual circumstances and may change in the future. If you are unsure about whether investing is right for you, please seek financial advice. Golden Sand Bank does not provide investment advice and personal recommendations.

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