A passive strategy has a more hands-off approach, while an active strategy involves the on-going trading of investments. An active portfolio strategy tries to generate maximum value by using as much information that is available and forecasting techniques to outperform a buy and hold portfolio.
What is Active Strategy?
Active strategy is something that all investors use on a daily basis, but to clarify, passive strategy is a more hands-off approach that is generally used when investing in a retirement account such as a 401k or an IRA. “Passive” doesn’t necessarily mean it is lethargic or lazy, in fact, the opposite is true. An investor who is said to have a “passive investing strategy” is simply letting the weight of the market determine when and how to buy and sell; the market will determine what price a stock will trade at, an active investor will be the one to initiate the price movement.
An active strategy, on the other hand is an investor who is quite active and that will make trades constantly. Traders who are referred to as “active” investors tend to make decisions to either buy or sell an investment due to external factors.
These factors or external triggers can range from a change in the sector an investment is in, a company offering dividends, or the opportunity to own a company that will generate a higher return than the rate of inflation. As you can see, the difference between passive and active investing is a fine line.
Most individual investors will use a healthy mix of both strategies; no one strategy is stronger than the other. In this article we will take a look at when an active strategy may be the better call rather than a conventional buy and hold.
Active vs. Passive Investing Strategy
Before proceeding you need to ask yourself if you are buying an investment or a company? Think about it, when you go to the grocery store you don’t find the top selling cereal, you find a cereal that you like. The same process applies for an investment.
Active investors will buy and hold a company they believe in and enjoy doing business with. This is done because the company is a strong investment, but sometimes the company is just a really good business. An active investor might buy a company’s stock and then sit back for years with no real trading strategies other than buying more stock in companies they like.
A passive investor will buy the stock in a company that they believe will perform strongly in the market over the long run. One of the factors in determining that “long run” is referring to the timeline of 10 years or more.
Passive investors will let the market and time dictate whether an investment is good or not. In most cases, passive investors will have more individuals in their portfolio due to gaining exposure to multiple sectors of the market as opposed to an active investor who will be allotted more funds to fewer investments.
Active vs. Passive Investment Strategy
The market has already determined the value of a company’s stock, and if an active investor trades stocks in and out of their portfolio on a daily basis, they might be trading stocks that have already hit their full potential. This is known as “buying high and selling low” which means that you are selling before the investment can reach its full potential.
Active investors will generally hold a stock for just a few days or a couple of weeks if the company is undervalued or overvalued. In most cases, stocks that are publically traded spend a certain amount of time between the “buy” and “sell” price.
When a stock is trading above an investor’s “buy” price, the investor will let the stock sit on their watchlist where it can be monitored and will wait for the stock’s value to drop to a price that they believe is a good value. Most value investors will invest in stocks below their intrinsic values when they believe that the value of the stock will eventually return to their intrinsic value.
Active investors will not only buy and sell individual stocks, they may buy and sell mutual funds and will also buy or sell put or call options as well as other derivatives. Due to the amount of time that is spent navigating the markets, the investor will attempt to do all of this trading from a home office or a place of business so that they may have access to financial software and financial news reports.
An active investor is constantly following market trends and will also be constantly allocating funds to investments as the market dictates what price a company should be trading at.
What an active investor will use to make stock price determinations is based upon several factors which include earnings, sales, speculation, and many more factors.
Does the investor believe that a certain company is losing market share to their competitor? This could mean that the stock is overvalued. What if the company is in a sector where industry analysts are predicting a slow down? At this point the company’s stock may be undervalued. This is considered to be an “accurate measure.”
What kinds of growth or profit margin trends are the company showing? This means more than anything; over the past five years, has the profit margin increased each year?
Those who invest in an active manner will generally think of trading as a side job. They will not make use of any time that could be spent on their main job, which is their source of income.
Trading stocks can be done in one of two ways; it can be done either during a break, or after hours. What if the market during the day reaches a “sell” point for a company that an investor owns? Does the investor pull the trigger then, or does he wait for the market to open the next day?
The answer to this, is that the investor will let the market determine what the shares of stock are worth. Waiting for the markets open price to be determined is referred to as “day trading.”
Day trading is defined by The Street as an active investment strategy that consist of opening and closing a position within the same day.
Day traders are independent of any brokerage firms, and manage their day trading portfolios using software that link them to the financial markets they are trading in.
Most day traders will start the day by looking at the historical price action for the stocks in which they are investing. If they believe the stock’s price is undervalued but is most likely to increase in price, they will set a limit order to purchase the stock.
When the price reaches that level the limit order is exercised and the stock is either bought or sold into the market which allows the investor to make a decent profit without having to continuously monitor the stock.
Active vs Passive Asset Management
Although we define active management as one with constant trading, there is another way of active investing, which is sometimes referred to as “passive management”. This type of management approach is not really passive at all, but buys and holds stocks without trading them. This is an extremely basic definition of passive management, as this simply describes “buy and hold” but not the trading of stocks.
An example of this would be with a mutual fund or an index fund. What this fund or index will do is buy companies that are in the index, and will not sell any of those companies. This is considered a passive approach since no stocks are traded and no stocks are sold.
There are discussions about he amount of tax dollars that go into the budget which would be otherwise going to other countries. The United States government holds a massive portfolio of companies, which in its own way is an active investor. Active investors have also been known to use short selling to profit from a decline in a stock price of a stock or industry sector.
Another active management approach is to buy the dips or buy at the lower price point of a stock or sector after it has moved upward. There is an important difference here as compared to the “buy the dip” strategy of traders and speculators. Traders and speculators will short the dip in the price of a stock, or buy put options to hedge their risk and protect the position they have in a stock, whereas passive investors will take advantage of the downward pricing of a stock without looking at the price they will be selling it at (p/e ratio, selling price per share, etc.)
Benefit of Active Management
Active management has some real advantages over passive management. For instance, if the investor feels they have a special insight into the company, the investor will most likely want to purchase shares for a lower price than what the market will allow. The investor thinks that the stock has an intrinsic value that is lower than the market value, and he will purchase shares based on that price.
Active management: there is no obligation to open an account, put it on auto pilot and not think about it again. Active management allows the investor to spend the time on something they enjoy and receive an income from investing.
Disadvantage of Active Management
Because of the time spent on investing in stocks, there is little time left for other activities. This can make it difficult for the investor who has other responsibilities.
Investing by using active management is a personal decision. There may be a lot of work involved but there are also a lot of rewards as well. The investor who chooses to use active management will need to be driven by a certain passion and be dedicated to the process to receive the highest benefit.
THE CASE APPROACH
Most of us work our entire lives to build wealth; this is why we rely on our 401(k) plans as a major source of income during our early years of retirement. However, if you are an active and committed investor looking to supplement your current 401(k) plan or IRA retirement, one of the quickest ways to achieve this is through active management or day trading.
By actively managing your portfolio, you will be able to build a substantial amount of wealth in a relatively short time, though you will need to follow a schedule and be willing to make trades at any time of the day. However, even those who are not as interested in active investing can make good use of a day trading management service.
Most, if not all, trading companies have web based trading programs where you can purchase individual stocks. Instead of purchasing and then keeping these stocks for months or years, you can make a successful trade and sell the position immediately. You will not be involved in the actual day trading but will receive a percentage of the funds earned from your investment.
This particular type of management is referred to as portfolio management, and it can be an equally useful tool. By placing a certain amount of your nest egg into index or mutual funds, you can make money from the funds without having to spend the time monitoring them. In addition to the management fees, you will receive a percentage of the profits the fund makes.
Is Active Management for Everyone?
Active management has its own disadvantages. If you are an aggressive investor and like the idea of trading in and out of positions at will, you will likely find active management more to your liking than portfolio management. However, if you are someone who likes the idea of making a certain amount of money on your initial investment and not have to do any trading, portfolio management is probably a better fit.
The time spent actually managing the portfolios, as well as the associated fees are also two factors to consider when deciding form one type of management over the other. It is also important to note that many of the investment firms that provide both kinds of management are among the most successful, so you will not be in good company. With any kind of management, you will want to avoid the larger mutual fund management companies.
Active Management Math
If you are a successful day trader, you will be receiving between 50-75% of all earnings made from your trades, with more money being distributed as you spend more time with a particular trading company. However, if you participate in a management service like the ones available at daytrading.about.com, you will make more money over time but the trade off will be more work.
If you are an active and successful trader, you will be receiving about 50-75% of the money earned from your trades.
If you are an active and successful trader, you will be receiving about 50-75% of the money earned from your trades, but with a management service, you will be able to make more money over time. Many of these companies will accept smaller institutions and deal with you directly, while some will only work with larger institutions and will send one of their managers to your institution to work directly with you.
This does cost you a bit more money up front, but it will give you a better sense of security and comfort. In either case, you should have a working environment that is as conducive to your trading as possible. You should have your computer and all of your trading tools ready to go in a matter of seconds. This can be done in a personal home office or in one of your company’s conference rooms.
You will need to get to know your manager well enough to ask him any questions that might arise before they come up. If you are not comfortable with your manager, or he is not comfortable having you as a client, the entire experience will be far less enjoyable.
Trading Wall Street actively is a time consuming process, and you will need to dedicate a lot of time to the process. This can take away from your other social and recreational activities, and some people find this to be a disadvantage. However, it also allows you to see where, when, and why the market is moving, and what types of events affect it. If you are someone who likes to be a part of the market’s action, “The Case Approach” may be a good way to go.
INVESTMENT PORTFOLIO MANAGEMENT AND ACTIVE MANAGEMENT AS A MEANS OF SAVING
Creating a wealthy future for you and your family takes money and investing. At different times in life, you have to invest in different ways. In the college years, you put money into good stock or mutual funds. In your thirties, you should have additional focused IRAs to meet short term needs. In your thirties and forties, you are building retirement wealth via your 401k plans. In your fifties and sixties, for many, you are converting from a savings plan to using more assets for income.
The key is harnessing the power of compound interest and capital appreciation. As the old saying goes, “you need to invest early to save early.” By the time your late twenties roll around, you should have invested enough to reach your goals or have put away so much that you are at a point where you can now take advantage of “active management” or “asset management.”
INVESTMENT PORTFOLIO MANAGEMENT
An investment portfolio management program or “asset management” is a program where you send money on a regular basis and the active management company, which might be a mutual fund family or a hedge fund, invests your money in a way that is geared to maintain high investment returns in the short and long term.
What is the best way to determine if an investment portfolio management program is for you? I usually begin by asking someone if they are looking to grow their money or if they are looking to maintain what they have. If it is the former, then investment portfolio management is for you. Let’s look at an example of how someone in their 30s might decide whether investment portfolio management is for them.
As mentioned above, many will go “all in” and invest in their company’s 401k plan and most will do their best to max out the contribution to this plan on an annual basis. If you can get by with letting this amount alone grow, then you might consider the investment management program on an active basis. Let’s say you are in the 30s and have let your regular 401k investments grow. You have just reviewed your investment portfolio management program and you found they have several funds that are geared to long term growth and several that are geared to short term. You then decide to invest in the funds geared to long term growth.
Now at the 40 or 50 mark, many are going to be more goal oriented with their investing. This means they may want to reach a certain age or have an income in retirement. Perhaps at this time they would like to implement an investment portfolio management program geared towards capital protection and income. When you reach this stage, you can look to have a greater percentage of your assets in funds that provide income and a smaller percentage in funds geared for long term growth.
If you are going to join an investment portfolio, manager you will be most likely being managed by a brokerage firm. This can be done through a Registered Investment Adviser (RIA) that is a broker dealer registered with the Securities Exchange Commission. This means the brokerage firm will be able to advise you about your entire portfolio and not just the fund portion.
One of the benefits of using a broker dealer or registered investment adviser is the ability to have a broker that you can use to transact your stock and options trades each and every day. This will give you close integration to the market and a valuable resource. You will also obtain educational and business support from the broker dealer.
Causes of Margin Calls
The margin requirement of a trader depend on two factors:
The assets a trader is currently holding in his account. How long will you be keeping these assets in your account?
The margin requirement differs between short-term and long-term holdings because the bank also needs to consider your forecasted maintenance margin in order to determine how much you need to have in your account.