Why active management is better than passive

At its most basic level, active management is an approach to the stock market which maintains that the greatest returns can be generated by moving in and out of stocks at the appropriate time. Of course “appropriate time” is the operative word, and within the world of active traders there is great debate about what that is. “Appropriate time” for some investors is based on a company reaching a specific price. For others, it may have nothing to do with the performance of a specific stock at all, and is triggered by “buy” or “sell” levels based on the overall market.

“Active management” is philosophically opposed to the “buy and hold” approach, which is based on the theory that an individual investor cannot outperform the overall market, and the prudent approach is simply to buy great companies and sit back.

Active management advocates would respond to that by saying it is no longer wise to take that approach. For example, for years if not generations there were few greater companies in America than Kodak. Kodak was a greatly loved iconic brand that enjoyed dominant market share and exhibited technological leadership. But dramatic changes in their industry – led by the move to digital photography – destroyed the company’s value and position.

The active management approach argues that market volatility – which has increased in recent years due to computer trading which moves large blocks of stocks extraordinary flashed –creates opportunities can be capitalized on. Active investors will often use trading techniques that include short-selling – betting that a stock will go down – as well as more sophisticated strategies that include “betting against the box,” collars, and many others.

Active investors range from those involved in day-trading to those who make frequent shifts in their portfolios. But as market complexity and volatility continue to increase, many who believe that the theory behind active investment is the right one – particularly as conditions are changing faster than ever before – find it difficult to implement that strategy in their own portfolios.

They either don’t have the time or expertise to make active trades, or haven’t found a money manager they fully trust or believe in.

One example of a firm that has emerged to fill that gap is Covestor, which can be found at Covestor.com. This firm makes a collection of skilled active managers available in a single place. These managers are located around the world, so that they can – according to the company – take advantage of local market conditions.

Potential investors can find a manager who best reflects their approach to active trading. For example, some are day traders; others aren’t making trades on a daily basis but take a very aggressive approach to keeping their portfolios current based on rapidly changing conditions, and the quickly occurring opportunities that result.

With the Covestor platform, an investor can look into a active money manager’s entire track record; interestingly, traditional managers rarely if ever provide a client with that access. Once an investor finds a manager they like, an account is established and the investor’s portfolios is “synched” to the managers so it mirrors each trade.

Given the fundamental changes in the economy in the U.S. and globally, it’s likely that the active management approach will likely grow in influence. Even Warren Buffet, the most famous “buy and hold” investor, has been taking a more active view of his Berkshire Hathaway portfolio in recent years.

For further reading on this topic, check out Smarter Investing′s blog article on active versus passive management here.

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