Active Investing: Understanding the basics

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Investing is a wealth-building tool that can be as involved or as hassle-free as you want. Active investing is a hands-on approach in which either you or a financial advisor acting on your behalf invests with the objective to outperform the market’s average returns. Passive investing involves investments in funds like exchange-traded funds and indexes that track and invest in the entire stock market and require little to no involvement from the investor to achieve average market returns.

For those interested in a more hands-on approach to investing, the active investing strategy may be more appropriate. Learn more about active investing and what you should consider before adopting this strategy.

Research is fundamental

Active investing comes in many forms, whether it is stock-picking on your own or through actively managed investment funds or portfolios created by financial advisors. The key to being successful at active investing is researching the fundamentals of any investment and ensuring that it meets your risk tolerance and aligns with your financial plan. Elements of this research include performing a comprehensive analysis of the company’s financial statements and other public reports to understand its business, revenue, cash flow, and debt etc.

It’s all about balance

When assessing the fit of an investment within a portfolio, investors or financial advisors are tasked with ensuring that it does not impact the overall balance. For example, if you invest in a company already held in an index fund you own, you are unknowingly increasing your investment in that company for better or worse. Suppose you buy too much stock in the technology sector, for instance. In that case, you may imbalance your portfolio towards that sector and see greater losses if that industry has a downturn, more so than a broadly diversified or balanced portfolio.

Know the risks

Generally speaking, active investing can yield higher returns but also carries with it higher risk. Even with comprehensive analysis, investors are not guaranteed high returns through picking individual stocks. In fact, more often than not, they underperform the market. The buying and selling of stocks can also expose you to cognitive or behavioural biases that can cause you to sell your investments at the worst of times or take on more risk than you are willing or comfortable to accept normally.

Active investing can be a great way to grow your wealth but is far more complex and involved than a passive approach. Fortunately, you are not restricted to any one strategy and can implement a blend of both passive and active strategies to create a portfolio that aligns with your unique financial plan, risk tolerance and goals.

 

 

Confronting the five cognitive biases of self-directed investing

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Money is a powerful tool in our day-to-day lives. There are various emotional connections and cognitive biases that impact how we spend, save, and invest our money. When it comes to investing, you perform the best when making informed decisions and approaching the market methodically and rationally.

Our investing behaviour is defined not just by the act of buying and selling investments, but also the psychological traps and misconceptions we have to contend with. Below, learn more about how you can recognize these negative biases and take a more calculated and successful approach with your investing.

Overconfidence effect: is a well-established bias in which your confidence in your judgment does not align with your actual accuracy and results. In investing, this can lead you to overestimate your understanding of the stock markets, ignore or disregard information and expert advice, take greater risks than is suitable for you, and ignore red flags of poor investments and fraud.

Herding behaviour (aka. FOMO effect): often linked to wild and irrational stock market bubbles, herding is the tendency for us to want to follow the crowd. The fear of missing out on the next big investment can influence you to make investment decisions in line with what you see and hear from others and less so on the fundamentals of the company you are considering. Fundamentals include profitability, revenue, assets, liabilities, and growth potential.

Confirmation bias: is when you have preconceived notions about a company or investment and seek out information that supports your beliefs rather than building a comprehensive understanding through objective research and data. This bias can make you invest in companies with a skewed sense of its business potential.

Loss Aversion: is the tendency for you to place more importance on losses rather than gains. This can lead you to hold on to a stock that continues to drop in value while all current rational analysis tells you to sell it. Inversely, this could also have you selling a stock that went up in value slightly to realize a gain, while ignoring analysis telling you that it should be held longer for a much greater profit.

Anchoring: is when you anchor your opinion and value of an investment to one piece of information or price and ignore the company’s fundamentals. Worse yet, anchoring can quickly lead to confirmation bias, having you look for additional information that aligns with your anchored belief in the stock.

Investing in the stock market on your own can quickly bring out these biases, impacting your investment portfolio. By recognizing when you are being influenced, you can better address the bias and ensure that your investment decisions are based on rational analysis. If investing on your own may sound too challenging, financial advisors and robo-advisers can lay out an investment strategy that will help you invest for the future and avoid these common psychological traps.