A simple introduction to passive investing; and how you can go about investing passively.
In our previous article, we talked about the differences between being an active or passive investor. In this article, we want to focus on just the passive side of investing.
What is passive investing?
In our view, passive investing represents taking a hands-off approach towards investing and aiming to achieve the benchmark market return. That means that the investor is not too concern with where the market is currently at, or whether a particular stock is trading at an undervalued price.
Passive investing does not revolve around careful manipulation of investing strategies and tonnes of knowledge on the hundreds of companies on the local index or even the thousands across the globe. The only thing an investor does is to settle for the benchmark return in the long-term, for example the local Straits Times Index, the S&P 500 or even a particular sector of the market.
Why passive investing works?
With the proliferation of the information-age, markets usually do a fairly good job of pricing in risks and a whole gamut of other information into its current trading price. Not surprisingly, studies have shown that actively managed funds have struggled to outperform the market returns over a sustained period of time. What this means is that even experience and knowledgable fund managers are unable to select stocks that do well on a consistent basis. Buying into passive funds takes advantage of the large volume of active traders out there creating efficient markets, so you are actually hiring them for free, and relying on them to equalise the market over the long run.
Aside from that, there are several other advantages worth considering:
(Almost) No knowledge barrier to entry
Even individual new to investing can take up this strategy, as there is virtually no knowledge barrier to entry. You can simply buy into a fund that tracks an index, or even an Exchange-Traded Fund (ETF). Talking to any financial consultant, and they’re not difficult to find, should direct you to the right instrument. Otherwise, JustAsk us a question and we’ll point you in the right direction.
Little upkeep needed
Passive investing is straightforward and does not require much upkeep or supervision. Everyone’s busy nowadays – busy working, busy playing, busy going (and sometimes queuing) at a club or just busy watching Suits. Passive investing is the way to go if you are one those who are simply too busy to bother about how the market is moving daily or even weekly. Simple review your holdings every month, for about half an hour to check for any changes in the index and to make sure none of the companies in it have gone bust. If you want to excite yourself up or appear knowledgable, spend the additional time you have planning for a bragging session with your active trading buddies.
Good value in the long run
Let’s say you continue your streak of not caring, and just want to put your money away knowing that the nest is growing. Guess what! Passive investing is for you. Besides lowering your chances of a heart attack in the current market conditions, being young and having the ability to hold long-term of up to 20-40 years will put you in good stead.
Historically, the stock market always gives higher returns because it is inherently more risky. As your holding period increases, the probability of a higher return also increases.
You typically incur far lower expenses buying into passive funds as the managers of these funds are tasked to track the index, not beat it. This makes sense as active funds do not outperform their passive cousins, and having large management fees just eat into your profit margins.
Now that you know the differences, we will leave it to you to judge for yourself whether you are an active trader or a passive investor. If you are someone who can neither afford the time nor have the ability to dissect companies’ financial reports, we advocate that you go down this route of being a passive investor.
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Royalty-free photo from Getty Images. Used with appreciation.