This article explains what exactly is passive investing, the benefits of passive investing and why it might be suitable for you.
What is Passive Investing?
Passive investing refers to buying securities or financial assets and holding them for the long term (at least 10 years or preferably longer) to make money from the investments.
At the same time, a passive investor does not trade regularly or spend time regularly attending to his/ her investments. Basically, passive investing is for people who do not like or want to spend all their time investing but still look forward to growing their money over time.
Unlike active investors, passive investors do not attempt to profit from short-term movements in the market. Passive investing is commonly referred to as a “buy & hold” strategy, but, there is slightly more to it than buying & holding onto the investments indefinitely.
Specifically, there is one form of passive investing that works especially well for many people. This involves investing not in individuals stocks or shares but investing in what are known as index mutual funds or ETFs (Exchange Traded Funds).
These are securities that track the market. To put it in the simplest terms, the fund or ETF consists of many different stocks of a number of the largest companies in a specific market. Depending on the market or specifications of the fund, a single index fund or ETF may comprise of 30 or 2000 stocks.
The benefits of investing into a fund or ETF is that you do not have to pick individual stocks as you own what the market considers the best ones.
You will have to buy a variety of low-cost index funds or ETFs (about 3 – 4) to create a diversified portfolio of stocks that will perform as the market does.
For simplicity, you can buy an equal value of each fund. So, if you invest in four ETFs, you will allocate 25% of your investment capital to each ETF and maintain this balance (allocation) through your investment life.
You will need to rebalance your portfolio periodically by buying and selling portions of the funds or ETFs so that the overall balance of the portfolio is maintained
Over time, some funds or ETFs will make money and some will lose money. So, you will have to sell some of the funds or ETFs that make money and use those profits to buy the funds or ETFs that have dropped in price. This rebalances your overall portfolio back to the original allocation.
Rebalancing forces you to buy slow and sell high, fulfilling a fundamental rule in investing.
While this may sound a bit technical and confusing, it is not as difficult as you might think.
Benefits of Passive Investing
It is Not Difficult
It is not difficult to build a portfolio comprising of index-based funds or ETFs that track the market as mentioned above.
You will need to know how to buy the funds through a funds company/ bank or ETFs through a trading account. But, you do not have to worry about learning how to pick the right stock
You will need to know which funds or ETFs to choose but that is a much narrower list to choose from and you can do an Internet search to find out the top recommends funds or ETFs to buy based on your country.
It will take you some effort to learn how to set everything up. But, once you set up your portfolio, you don’t have to worry about it too much.
It Does Not Take Up Too Much Time
Passive investing requires time initially to learn and set up the portfolio. But once done, you need only attend to the portfolio once or twice a year.
So, passive investing is perfect for people who do not have time and/ or have no desire to keep up with financial news and watch closely over stocks.
Passive investing allows you to focus on developing your active income as well as other passive streams of income. It allows you to do things you want, spend time with people you love and enjoy life.
Lower Risk with Good Value in the Long Run
Passive investing in the form of index-based funds or ETFs that track the market is not high-risk investing. While there is no such thing as no risk, this form of investing generally gives you positive returns in the long run. As your holding period increases, the probability of a higher return also increases. The chances of you not making money over the long term are very low.
But bear in mind, the market moves in cycles. There are upturns and downturns. These cycles roughly run for 7 – 10 years at a time. Ideally, when you cash out for retirement, it should not be at a time when the market is down. However, as a long-term passive investor, you will be able to find out what the current market conditions are at that time and can plan accordingly. Any major shift in the market will take months if not a year so you have time to react.
There are Fewer Ways to Make Mistakes
The beauty of holding index funds or ETFs that track the market over the long term is that you don’t need to constantly make investment decisions that could make or break your portfolio performance.
As long as you stick to the plan of setting up your portfolio, rebalancing it periodically and holding your investments long-term, you will not make rash or impulsive mistakes that could cause you to lose money.
It is Less Stressful
This form of passive investing is not affected by short term market movements or the constant ups and downs of stocks resulting from every piece of financial news, results or speculation. The emotional toll of investing in equities can be very taxing. Passive investing reduces the stress for the investor. Over time, a passive portfolio is likely to do well even if there are downturns in the market because passive investing is based on the total market.
It is Cheaper
Passive investing incurs far lower trading transaction costs because the funds or ETFs are designed to track the market, not beat it. You only make trades periodically to rebalance the portfolio when necessary. Active trading to try to beat the market can be expensive as you will be racking up transaction costs for every trade you make and there is a higher possibility of making mistakes and losing money.
Learn the 6 Steps to Passive Investing HERE.