Active Management is the portfolio management approach for optimists. It’s costlier and riskier but the upside is it may pay off better over the long-term.
The glib response to the question of, “What is active management?” would be, “The opposite of passive management.” The more helpful answer would be that it’s a term which refers to professional money managers or teams of managers who take an active role in improving the portfolios of their clients by frequently making buying, holding and selling decisions for all of the assets that such portfolios contain. Their overall job with active management is to use a variety of intelligent strategies to help their clients’ portfolios beat the market. They’ll be looking for undervalued stocks to invest in, identifying them through fundamental analysis, and buying them when they see an opportunity.
The idea that investors can outperform the market in the long term is seen as not just optimistic but downright heretical by those who subscribe to an idea called the efficient-market hypothesis (EMH). EMH says that over the long run, active management will produce no better results than if you simply put your money into every stock in the market itself. Still, active management remains popular, because sometimes and for some people you can beat the market.
We mentioned passive management as being the opposite of active management. Its other name is indexing, and it refers to the more conservative approach of building up a portfolio of stocks and simply waiting for the index to rise. There is no active management with this approach because you’re playing the long game and banking on the historical truism that the market always rises over time. Such strategies are often linked to mutual and exchange-traded funds (ETF).
If you opt for active management then you’re choosing to accept a higher amount of risk in return for potentially greater rewards, and you accept that you’ll be paying more for the privilege too. Active management is done by active managers, so you’ll be paying for their time and expertise.You’ll still pay for a passive management strategy of course, but not as much, and though you might make less on your investment over time, you have a much better chance of success. There are no guarantees of course but active management is definitely riskier.