Active Investing

What it is:

The opposite of passive investing, active investing is an investment strategy that advocates significant trading and a short-term horizon.

How it works/Example:

Active investment strategies generally dismiss long-term trends and focus on short-term profits, whereas passive investors maintain that long-term price movements are important and often predictable. This is why active investors often use quantitative and technical analyses, including ratio analysis, stock chart analysis and other mathematical measures to determine whether to buy or sell. The passive investor is likely to rely more on fundamental analyses and evaluations of an investment's long-term potential, which is the passive investor's typical investment horizon. The active investor's investment horizon can be months, days or even hours or minutes.

Why it Matters:

The biggest advantage to active investing is that investors can profit from short-term run-ups and other opportunities. Passive investors argue that these occurrences are random and unreliable, although they are an active manager's bread and butter. Ultimately, the investor's personal goals, risk tolerance and portfolio size highly influence the choice of a passive or active strategy. And even though passive managers enjoy a large and loyal following among investors, most encourage even the most passive investors to take a page from the active investors and learn about and understand active management methods, stay current on their investments and know how to read stock charts.

However, active investing tends to be riskier, and active managers frequently fail to match or beat the indexes in which passive managers are invested. Many active investors do not espouse the efficient-markets hypothesis, which says that securities prices are random and already reflect all available information. Instead, they believe that financial, economic and demographic information can in fact indicate which way a stock will go.

Active investing generally requires more time and education than passive strategies, and there is significant controversy about whether a portfolio's overall return is much more affected by how the portfolio is allocated rather than the specific securities chosen (and stock picking is domain of the active investor). Active investing is often more expensive: it usually requires more in trading commissions and advisory fees and can have fewer tax benefits when short-term capital gains tax rates are higher than long-term capital gains rates.

Best execution refers to the imperative that a broker, market maker, or other agent acting on behalf of an investor is obligated to execute the investor's order in a way that is most advantageous to the investor rather than the agent.