The trading direction of individual stocks or the broader financial markets can often change without warning. In order to respond to this unpredictability, an active investor is involved with the day-to-day management of an investment portfolio and makes frequent changes to reflect new buying and selling opportunities. An active investor is a stark opposite to a passive investor, the latter of which invests according to another market index in hopes of performing in line with that barometer and makes infrequent changes.
Professional money managers are often the investors behind an active strategy. These managers are paid to create investment portfolios that outperform the returns that are generated with a passive style. Investor clients traditionally pay a professional active investor higher fees in order to earn greater profits in comparison with fees paid to a passive professional investor. When those expected returns are not realized over a period of time, it is sometimes cause for clients, which include large institutional investors such as pension funds, to switch to passive management.
An active investor operates under the premise that there are inefficiencies that exist in the financial markets. Essentially, an inefficiency is a lag in the value of an investment, such as an equity stock, and all of the information that has the potential to influence the trading direction of that security. An active investor believes that he or she can capitalize on those market inefficiencies by investing in undervalued stocks and selling overvalued stocks for a profit. This individual makes trades and changes to an investment portfolio based on conditions not only surrounding an individual stock but also economic and market circumstances that influence stock performance.
It is possible that an active investor generates the best returns when a long-term investment approach is adopted. When investing for a long-term goal, such as retirement, an investor is likely to experience changing market cycles. By taking a long-term approach, there is a greater chance for an investment strategy to reach its full potential and for investors to earn the greatest returns. In the short term, it is possible that market volatility will intercept some of the returns that could otherwise be realized over time.
Decisions reached by an active investor may be driven by risk. This does not mean that an active manager will always shun risk. Sometimes, chances need to be taken in order to produce the types of profits that are expected. At times, it may mean that certain stocks or other investments are replaced with others that pose less risk and introduce greater stability to a portfolio.
