Building Wealth Through 'Active' Investing
How should I invest if I have an 'active' investment personality?
If you have an active or consumed investment personality, you already know it, for one. You live and breathe for investing. We need to create a strategy that is right for you. Something that satiates your desire to learn and to be involved in the markets, but that's also an effective strategy. Not one where you are buying and selling through out the day, but one that takes a look at the overall big picture and really focuses on your strengths as a consumed investor. And so, the strategy there, similar to the involved investment personality, you are using index funds. But, the difference is youre also going to be using active mutual funds. So its the combination of index funds and active funds that make up the consumed or active investment type.
What are 'actively-managed' mutual funds?
Actively managed funds differ from passive index funds in that one is passive and one is active. A passive fund again tries to focus on a particular benchmark. If it reaches that benchmark, that's fine. The active manager, they're not just happy with meeting the benchmark. They want to do better than the benchmark, so they're going to be buying and selling throughout the day, throughout the week, throughout the quarter - trying to do better than just the benchmark.
What are the advantages and disadvantages to the active investment strategy?
One of the biggest advantages with the consumed, or active investment strategy, is that you have the ability to beat the market and beat the benchmarks. Because you're using the active managers, their goal is to beat their benchmark. This is the one strategy where you might actually do better than the involved or the consumed. If you don't over-trade and if you don't make too many decisions in the quarter, you can actually do better. The disadvantages, of course, is that it takes a lot of work, takes a lot of time, takes a lot of research to figure out how you want to allocate your investments, and then finding the best active managers. I was saying earlier that there are 18,000 different mutual funds out there. As a consumed investor, part of your job is to find out what are the best 10 or 11 managers for my portfolio? It takes a lot of work.
What is an 'efficient' versus 'inefficient' asset class?
An efficient and inefficient asset class. Now, here's an example: With an efficient asset class, basically if the CEO of a company sneezes, everybody knows about it. That means that information travels very, very quickly. If something happens, everyone knows about it, and they all know about it instantly. The example they use is Microsoft. There are thousands of analysts looking at Microsoft, reviewing their numbers on their quarterly earnings calls, looking at all of the different things and markets they're going into. Everyone knows everything they possibly can about Microsoft. That's an efficient asset class - if something changes, everyone is going to know immediately. The flip side to that is an inefficient asset class. With an inefficient asset class, they can be developing products and strategies that people won't know about, or might not know about for weeks or months. Information travels very, very slowly. So the advantage with an inefficient asset class is that you can learn something that a lot of other people don't know about. Once you have that information, you can capitalize on it and take advantage of it by investing in that company. Whereas a big, large company - efficient asset classes - you think you might know something that no one else does, but you don't - everyone else knows it.
How should I allocate my assets in an active investment strategy?
If you're a consumed investor you've got to consume strategy. The approach is that you need to create an asset allocation - a mixture of stocks and bonds - and you have to create that allocation yourself. You then mix both index funds, passive funds with active managers. The question is, "what do I use index funds for and what do I use active managers for?" Well, for the efficient asset classes, remember those asset classes where the information forms very quickly, and everyone knows everything? You might as well use an index fund because an active manager is not going to be able to know anything to really be able to beat the benchmark. But for those inefficient asset classes, for example small cap securities or international securities, those are areas where an active manager, through his or her research, might actually know something that others dont. So those are the asset classes where you want an active manager.
When should I rebalance my portfolio in a 'consumed' investment strategy?
A consumed investor should look at their portfolio once a quarter. A consumed investor should do this once a quarter - they're probably doing it once a day, but in the best case scenario, do it once a quarter, and see if anything has changed in your financial outlook or economic outlook. If it has, you might want to shift your portfolio around.
How can I choose the best actively-managed mutual funds?
There are nearly 18,000 different mutual funds out there and most of those are actively-managed funds. Finding a really good active-manager is like finding a needle in a haystack. It's very, very difficult. What I would recommend are, one, going online, doing some research, and looking at the performance of the active-manager. You want to make sure that the active-manager that you're choosing has beat their benchmark in the last one, three, five and ten years. That's a good indication that these active-managers are actually doing their job pretty well. You want to look at the expense ratio. I would look at funds that are less than one-and-a-half percent. Don't go above that. You're really not paying for much when you go past one-and-a-half percent.
Why should active investors buy mutual funds rather than individual stocks?
I don't recommend individual stocks for a few reasons. One, you're just taking too much risk owning a single company. I mean look at Worldcom, look at Enron, look at all of these companies that people thought were fantastic. You may have done a tremdous amount of research into the company, focused on their numbers, focused on what their branding was and their strategy going forward. Everything may look good, but then again, you just don't know - and if you have all of your eggs in one basket and you drop the basket, guess what? You're done. By using mutual funds, both indexed funds and active managers, you're spreading your risk out, and you're doing it very effectively and very strategically, so you don't have all your money in just a handful of companies.
