Risks Of Active Investing For The Part-Time Investor

Active investing can be highly rewarding but it comes with more risk.

What most personal finance gurus advise people to do it leave your investments in mutual funds.

Mutual fund managers’ entire job is to monitor the market and make shrewd investments.

Generally speaking that is good advice.

Mutual fund managers have the time to delve much deeper into company financials and market trends.

They should be better than us at managing money in the stock market.

On the whole, that’s correct.

I’m sure almost every mutual fund manager can manage a pool of billions of dollars better than we can.

They do have trouble beating the overall market.

Most Fund Managers Don’t Beat The Market

In 2021 around 60% of fund managers are underperforming relative to the S&P 500.

Sometimes it is because these fund managers want to offer options that are more conservative than the market to help people protect their wealth.

Older investors typically look to increase their bond holdings in order to retain the wealth they’ve accumulated.

A lot of mutual fund managers hold bonds to appeal to this investor class, or they assemble funds for exposure to certain industries.

If you are a young investor and want an aggressive investment strategy, you should not be in these funds.

Use your after tax savings to invest in growth funds.

You have time to incur losses and bounce back, so a reasonably aggressive approach would benefit your portfolio better.

Some Fund Managers Do Beat The Market

40% of managers do beat the market! That’s a large amount of funds to choose from.

Invest in these funds!

Do your research and identify the funds that regularly beat the market.

Keep in mind that past performance is not indicative of future results.

Anything can happen to your funds, and there is not a guarantee that any fund will continue to under or over perform the market.

Take the ARK funds as a recent example of a fund’s fortunes changing drastically.

It’s innovation fund TICKER: ARKK is down -17.94% at the time of writing compared to the S&P 500 index which is up +17.74% year-to-date.

Take the time to do your research and keep the amount of risk you’re taking on in mind.

Do not forget to check the fees that funds charge.

Funds that aim to beat the market often have huge fees, only to underperform a cheap index fund.

Actively Managing Your Own Investment Fund

Some people treat their investment accounts as their own fund.

They trade individual stocks and options instead of mutual funds & indexes.

This is obviously the most risky way to manage your money, as individual stocks are prone to much greater movements than larger funds.

Most people do not diversify enough with their individual holdings which leaves them overexposed in some industries and lacking exposure in others.

Mad Money Advice

Jim Cramer has solid advice on how to structure your investment account.

He suggests on investing your first $10,000 into a low cost index fund.

It’s important to look at a fund’s prospectus to understand the fees they charge, and also look at fee that your trading platform has on funds.

TD Ameritrade has a $49.99 charge on No-Load mutual funds as an example, which isn’t a big deal if you’re investing a couple grand but it is if you invest a couple hundred dollars.

After building up $10,000 in your index fund Cramer suggests keeping around 10 diversified individual stocks in your portfolio.

He claims this is a manageable number of companies that allows you to still keep up with quarterly and annual reports.

Options Trading

Options can get a little tricky, but there are two basic forms of options. Calls and puts.

Calls give you the option to purchase (call) or sell (put) a stock at an established price by a set deadline.

So with these options, its beneficial for you is a stock’s price increases with a call, since before the increase you’ve locked in a purchase price.

You essentially have the right to purchase shares for a discount from their market price.

The opposite is true with puts. You stand to benefit if a stock’s price goes down because you have the right to sell the stock for a price that is higher than it’s current market price.

A lot of trading of options happen, but it’s common for options to not actually be executed.

Options Trading Is Risky

For most part-time investors options are too risky of a strategy to effectively execute.

I would say they are one of the riskiest strategies available to most investors.

I got burned with options after initially having some success with them.

It’s important to remember that us casual investors are woefully under-informed compared to the massive institutions that execute thousands of complicated trades every day.

If you are interested in options make sure to do your research and really understand the risks.

Meme Stocks

You might have heard about “meme stocks” during the past year. One of the biggest has been AMC.

AMC was in financial trouble during the pandemic because lockdown restrictions were impacting their business model.

Investors on Reddit saw that many of the large hedge funds and money managers were shorting (buying puts) on AMC.

Many of these Reddit investors were avid AMC customers, and were determined to not let their favorite movie theater franchise go out of business.

They started buying AMC en masse which drove the price of AMC up and screwed the short sellers because they now held options that were essentially worthless.

They had the option to sell AMC at a price that was below the market price, which of course no one wanted to exercise or buy the options.

What do you think? Do you prefer active or passive investment funds? Do you trade individual stocks? Are options a good long-term strategy? Let me know in the comments

Author Bio

Drake is a freelance writer who’s interested in history, economics, art, & beer. Drake graduated with a degree in Supply Chain Management and began working at General Motors. He writes about popular personal finance topics and shares his journey. Make sure to check back for more posts on Abnormal Money.