Active investment strategy

Definition

An active investment strategy is an approach to investing where an investor or fund manager makes specific investment decisions with the goal of outperforming a benchmark index. This strategy relies on the skill and research of the investor to identify mispriced securities or trends in the market. Active investors continuously monitor their portfolios and make adjustments based on market conditions, economic indicators, and individual stock performance.

5 Must Know Facts For Your Next Test

1. Active investment strategies often involve higher fees compared to passive strategies due to management expenses and frequent trading costs.
2. Active investors believe they can achieve returns that exceed those of market indices by exploiting inefficiencies in the market.
3. Performance is typically measured against a relevant benchmark index to determine if the active strategy has been successful.
4. Successful active investing requires extensive research, analytical skills, and a deep understanding of market dynamics.
5. Not all active managers consistently outperform their benchmarks, with many studies showing that a significant number fail to do so over long periods.

Review Questions

• How does an active investment strategy differ from a passive investment strategy in terms of decision-making and objectives?
  • An active investment strategy focuses on making specific investment decisions with the aim of outperforming a benchmark index through skilled analysis and timely trades. In contrast, passive investment strategies typically involve less frequent trading and aim to replicate the performance of a benchmark rather than exceed it. The key difference lies in the approach; active investors seek to capitalize on market inefficiencies, while passive investors accept market returns as they are.
• What are some advantages and disadvantages of employing an active investment strategy for managing a portfolio?
  • One advantage of an active investment strategy is the potential for higher returns by identifying undervalued securities or market trends. Additionally, active managers can quickly adjust portfolios in response to market changes or economic shifts. However, disadvantages include higher fees due to management costs and trading commissions, as well as the challenge that many active managers face in consistently outperforming their benchmarks over time. These factors can impact overall investment returns significantly.
• Evaluate the effectiveness of an active investment strategy compared to passive strategies in light of historical performance data.
  • Evaluating the effectiveness of active investment strategies reveals a mixed picture when looking at historical performance data. While some active managers have successfully outperformed benchmarks during certain periods or in specific markets, numerous studies indicate that many fail to do so over longer timeframes. As a result, passive strategies have gained popularity due to their lower fees and consistent performance relative to the market average. Investors must weigh potential rewards against risks and costs when considering which strategy aligns with their financial goals.

Related terms

benchmark index: A standard against which the performance of an investment portfolio can be measured, often composed of a group of stocks that represent a particular market segment.

portfolio management: The art and science of making decisions about investment mix and policy, matching investments to objectives, and balancing risk versus performance.

market timing: An investment strategy that attempts to predict future market movements in order to make buy or sell decisions at the most advantageous times.