Ultimately, there are two ways to invest. Most people are passive investors who, for good reason, shy away from risk and stick to their long-term plans regardless of what happens in the stock market or the overall economy. Then there are others who choose to be active investors, taking on much more risk for a chance to beat the market.
Active investing styles are generally not recommended for the average person. But in recent weeks, financial giants such as UBS Wealth Management and BlackRock have said that the coming year and beyond will be better suited to active investors than passive ones.
“When I think about the Alpha opportunity [beating index funds]that’s where I get really excited, the most excited I’ve been in 20 years, actually,” Tony DeSpirito, BlackRock’s head of fundamental equity investments, said in a December meeting.
Institutions are excited by the prospect of beating the market and are confident enough to take the risks of active investing to do so. But is this a viable strategy for retail investors, and should you consider becoming more active with your investment portfolio in 2024?
Active investments and passive investments in 2024
Active investing is, at a basic level, just as it sounds. Active traders tend to check their portfolios frequently and constantly evaluate the value of assets. They use their own benchmarks to evaluate stocks to hopefully identify investments that “beat the market” or outperform standard index funds that track the S&P 500 or other major market indexes.
More specifically, active investing is an approach that “really tries to make discretionary decisions,” according to Joy Yang, head of product management and marketing at MarketVector Indexes. “They use theirs [investment portfolio] to achieve an investment objective. That could mean outperforming some kind of benchmark or generating income or preserving capital,” she adds.
Passive investing, on the other hand, follows a “rules-based approach,” rather than a discretionary one, Yang explains. “Even broad, pure market benchmarks like the S&P 500 or MSCI World are rules-based approaches, because someone had to define the rules at the beginning: the investability criteria or what the weighting scheme is.”
More specifically, passive investors tend to adhere to much safer “set it and forget it” investment approaches. By identifying fundamentally strong, long-term strategies, passive investors will hold onto their investments during any type of short-term changes in the market. By eliminating the time element and momentum of active investing, this is a strategy that retail investors are wise to use to minimize risk to their money.
In recent years, passive investing has become increasingly popular not only among individual investors but among financial institutions as a whole. The economic crisis that the entire world was facing at the beginning of the pandemic led the Federal Reserve to significantly lower interest rates and significantly ease its monetary policy. “It really was a rising tide that lifted all boats,” DeSpirito said.
However, BlackRock and others expect active investors to be rewarded more handsomely in 2024 and into the foreseeable future as the Fed prepares to cut interest rates and tries to prepare the economy for its goal of a soft landing. There are already positive signs in some areas of the economy, such as the historically low unemployment rate. More is expected to be on the horizon, with mortgage rates becoming more favorable and inflation moving closer to the Fed’s target rate of 2%.
With macroeconomic factors changing like this, these institutions say index funds may not deliver the gains achieved in previous years, so they argue it’s now more worth the risk of actively investing. In its January note, BlackRock advised investors to hold Some index funds in their portfolios, but lose some to actively managed investments.
Is active investing right for you?
With all this in mind, active trading is not a strategy often used by retail investors. This tends to go against many rules of thumb, such as holding long-term investments and not trying to time the market.
Active investments are also quite difficult to complete successfully. Even fund managers who have spent years developing active investment strategies and bespoke valuation systems rarely tend to do better than passive strategies.
“Historically, active managers have never beaten the market overall,” Yang says. “There could be really competent active managers,” she adds. But, given that only 7% of active funds have beaten the market over the past decade, according to S&P’s most recent Scorecard report, these successes are few and far between.
Of course, there are ways to actively invest without having to do all the hard work yourself. There are many actively managed investment funds, where investors give their money to fund managers to invest. However, buy-ins for many actively managed funds are quite prohibitive for the average retail investor. There are high requirements to participate in some of these funds, with a minimum of $100,000, high fees and strict guidelines.
If you’re not wealthy, or if you understandably don’t feel confident enough to take on the significant risks of actively investing on your own, it may seem impossible to participate in what some might call “the year of active investing.” But Yang highlights an investment that is becoming increasingly popular: active ETFs. Active ETFs like BlackRock’s iShares represent a small but rapidly growing portion of the ETF market. And they don’t require large buy-ins from other active funds, since ETFs have no minimums; you just have to pay the cost of the actions you want.
“I think active managers have woken up to the fact that the ETF structure is so popular, and a lot of them want to wrap their strategies in an ETF,” Yang says.
Yet another disclaimer: Many active ETFs are simply mutual funds in a different “wrapper.” While the cost of participation is much lower through these products, remember that active managers still do not regularly beat the market. In other words, there is no guarantee that active ETFs (or mutual funds) will perform better than a basic index fund.
Ultimately, in most cases it is not wise to actively invest alone. It is research-intensive and requires a level of expertise not possessed by most people. If you want to engage in active investing, Yang says turning to a reputable financial advisor is your best bet. Or, at the very least, you should recognize that by actively trading based on your decision making, you are taking on more risk than simply holding an index fund.
“For individuals, it is still best to use an investment advisor,” he says. “[Advisors] they can actively allocate based on your investment objectives, your risk profile, and their understanding of some of the macroeconomic factors occurring in the market. This is where I see active management going more: directly towards development allocation rather than bottom-up stock selection.
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