Also known as passive management, passive investing involves strategies that don’t try to outperform the stock market, and the belief is that to boost your returns you do as little buying and selling as possible.
Don’t get us wrong though, it’s still a thoughtful process that aims to mirror the market.
It’s a go-to approach for many investors, but you need to know what you are doing. In this article, we tell you all about passive investing and give you a breakdown of the pros and cons of joining this trend.
What is Passive Investing?
Passive investing is a popular investment strategy. The aim of passive investing is to maximize profits while minimizing buying and selling. This long-term strategy is used by both beginner and experienced investors alike.
Passive investors hold shares in stocks or other assets for long periods. This slowly builds up your wealth over time. Passive investors try to match the market, and not to beat it. This is different from active investing, which is a more risky and vigorous strategy.
Understanding Passive Investing
As a passive investor, your goal is to match the performance of certain market sectors, not to outperform them. Passive investors aim to diversify stocks in a given market index.
The secret to passive investing is boosting returns by doing as little buying and selling as possible. This strategy is simple to understand and easy to manage. It has become a popular go-to approach for many investors.
The ultimate goal is to build up wealth slowly, as opposed to making quick profits. Investors rely on the fact that the stock market always tends to go up over the long haul. If your portfolio matches the market, it will appreciate along with it.
Passive trading strategies tend to outperform active trading strategies in the long run. This is why many passive traders invest in passive investment vehicles. These vehicles include exchange-traded funds (ETFs) and other index funds.
There are several key characteristics of a passive strategy.
Choose a position and become familiar with it
It is important to thoroughly research the sectors of the market you want to invest in. When you become more familiar with the stock, you will have a better understanding of price movements. You need to know if price movements are due to normal volatility or something more significant.
Watch the chart movement and the news flow
You need to keep an eye on price movement when it comes to news flow. Some trades might have future catalysts that you need to look out for to make a move in your portfolio. This might be movement over important technical levels or the anticipation of positive returns. You should track charts and news flow closely. These might indicate volatility in the market that you use to make extra buys or sells.
Know when to change portfolio positions as market conditions develop
As market conditions develop, you need to know when to ramp up a position or cut it back. The main goal is to have a diverse portfolio that matches your chosen sector in the market.
Types of Passive Investments
There are several types of passive investment strategies. The most common passive investments include index funds, ETFs, and mutual funds.
Index funds are the most common passive investing approach. Assets held in the fund usually represent a certain benchmark on the market. Index funds make it easy to track specific individual investments within the fund over a long period.
Exchange-traded funds (ETFs) allow you to track a selection of shares within a market sector. You can trade ETFs on an exchange. These offer a more cost-effective route to investing compared to other investment funds.
Mutual funds are collections of money from many investors used to invest in various securities. These investments are managed through a brokerage firm or directly. Mutual funds come with added costs and trading penalties.
Pros and Cons of Passive Investing
There are many benefits to passive investment strategies. Here are some of the most notable advantages.
- Low costs: Passive investments generally have low account management fees. They are easier to manage and require less active oversight.
- Simplicity: Passive investment funds are easy to manage. These are more simple to understand compared to active strategies that need constant oversight.
- Low risk: This strategy comes with very little financial risk. Based on the funds you choose, you can diversify your holdings further with more targeted index funds in certain sectors.
- Transparency: It is always easy to track where your assets are in a passive investment fund.
- Tax efficiency: The long-term nature of a passive fund generally means that you avoid tax on your profit. These usually do not generate enough capital gains tax for the year.
On the other hand, there are several downsides to passive strategies that you should be aware of.
- Smaller potential returns: Passive funds aim to grow with the market, not to beat it. Core holdings are locked, even during volatile market times. This means that passive funds won't bring in big returns. Active investors can bring in bigger rewards, although this does bring greater risk.
- Investment limitations: Passive funds limit you to only specific investment products. These are limiting as they lock you into a holding, regardless of what happens on the market.
Passive investing is an easy and low-cost investment strategy for both beginner and experienced investors. The strategy's main aim is to reap financial benefits over a long period. A passive investment fund means that you don’t need to spend a lot of time watching the market and researching stocks. While the buy-and-hold approach has many advantages, it isn’t the best for everyone.
Ultimately, passive investing is suited to investors with long-term objectives. If you prefer being hands-off to save up for retirement, then a passive approach is for you.