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What is active investing?

Active investing is a term that is used by many people in a number of contexts and seems to have quite an elastic meaning. To try to clarify the idea, lets start with what it is NOT:

It is not passive investing. Passive investing is essentially the buy-and-hold method. A broadly diversified portfolio of shares is built up over time and held with minimal changes. It might be added to from time to time with fresh capital or by reinvestment of dividends. This will change the portfolio mix slightly as time passes, but movements in prices will be the main force to change the mix within the portfolio as some stocks do well and others lag.

The indexed approach is a specific form of passive investing, however, in the sense that it requires rebalancing when stocks move in or out of the index or change their weighting, it has active elements.

It is not short-term trading. This is the other extreme, where capital is actively traded over periods varying from day-trading (positions are opened and closed within one day) to several days or maybe a week or so.

In between these extremes, we have a broad range of approaches that might attract the term active investment.The aim is to be an investor, rather than a trader. A trader focuses on capital gain exclusively. An active investor focuses on total return (dividends plus capital gain) and will be also cognizant if the taxation impact on the process.

The active investor will hold positions from a few months through to several years. The shorter end will be fully taxed, but most of it will be taxed under the capital gains tax regime. Dividend imputation will also be an important factor, so the 45 day rule will also be on the active investor's radar screen.

The active investor may be quite active and risk being seen as a trader for tax purposes, but most will stay well away from that area. there are really two kinds of active investor:

Conventional fund managers. They will tend to try to pick stocks for their portfolio that they think will do better than the index and therefore is the rationale for the fees they charge. The fund size may limit their ability to actively trade the portfolio, so they will tend to increase or decrease core holdings, rather than sell out of them entirely. It is best seen as a bias to stock picking to add value. Of course, sometimes a holding is sold completely and new companies selected to replace it. There are some with portfolios of hundreds of stocks and some with quite narrow portfolios of maybe only 20 stocks or less. Where the fund holds asset classes other than shares, there is also active switching within the band they have set for shares as a proportion of their total assets.

Position traders. Their approach is based on being very active in stock selection. They are trying to capture medium term movements in share prices as the market re-rates a stock upward for any reason. When that process is seen to be completed, they will sell out of the stock and move on to another.

Between the conventional fund manager approach and position traders there is a range of approaches between the two, with the main difference being the time frame they focus on and their ability or willingness to move completely in or out of any specific stock.

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