For new or inexperienced investors, passive investing may seem an alluring way to invest in the markets. We don’t have to spend much time or effort in our investments, yet still collect market returns over the long-term.
Even for more experienced investors, passive investing offers a stress-free method to accumulate wealth in the long-term without worrying too much about short term price volatility, economic performance or industry cycles.
What Is Passive Investing?
Before we go into what passive investing isn’t, here’s what passive investing is.
Passive investing is when you take a “buy-and-hold” stance. This means that we buy stocks with the intention to hold them for the long term, rather than try to time the market by getting in only when we deem valuations to be attractive or getting out after making a quick buck or because we get fearful after a slight dip. In short, we don’t let emotions dictate our actions.
By investing for the long term, we are also trying to achieve market returns rather than gun for stellar returns. Market returns is typically defined to be the returns that all the stocks in the market deliver on average. The best way to achieve market returns is simply to invest in the market.
Even with little skill or research, you can gain access to a well-diversified portfolio of some of the strongest companies via exchange traded funds (ETFs) and mutual funds. Another way to embark on passive investing is to regularly contribute to a monthly investment plan (MIP) that buys into ETFs or individual stocks.
The ETFs you focus on should comprise a diverse base of strong stocks within specific countries (country indexes), regions or industries. If you’re investing in individual stocks, you want to ensure that you split your investments in several blue-chip stocks. This way, you diversify your investment portfolio while continuing to accumulate stocks of strong companies.
Of course, this also means you don’t invest when friends give you “hot” stock picks or simply when you feel like it. You also don’t sell based on market fluctuations or economic cycles.
Having read about all the benefits of passive investments, we may be ready to (or have already) put our money into it.
Hang on a second, here are four ways you may not actually be passive investing even though you think you are.
# 1 You Go In With A Passive Investor Mindset Only To End Up Buying And Selling Based On Emotions
This is the most common method in which passive investors end up failing, and become active investors.
Shortly after embarking on your passive investment journey, via investing in major country indexes such as Singapore’s Straits Times Index (STI), Hong Kong’s Hang Seng Index (HSI) or the USA’s Standard & Poors’ 500 (S&P 500) Index, you decide to get out of the investment.
This could be due to sudden plunges in stock prices, greater uncertainty in the global economy or because you’ve become consumed with fear or greed after watching daily stock price movements.
By reacting this way, you’re simply not being a passive investor. Passive investors take the market return – regardless of whether the market return is positive or negative.
# 2 Your Passive Investments Are Only Done At The Right Price
We fail right at the beginning – either waiting for the right price before making our “passive investments” or only enter “passive investments” because they’re at a price we think is attractive.
Even though we have every intention of holding these investments (or investments-to-be) for the long term, the problem is that we only want to go in at an attractive price. Ultimately, this is still timing the market, because we would never make these “passive investments” if they weren’t trading at an attractive price.
# 3 Passive Investments In Active Funds
Investing passively does not equate to passive investing.
Think about a situation where you are regularly contributing a portion of your salary to an investment each month. Mainly, this happens when you invest in stocks, ETFs and mutual funds via a monthly investment plan (MIP), but could even be with your investment-linked policies (ILPs).
Technically, you are investing passively – without trying to time the markets nor attaching emotions to your decisions. However, the funds that you’ve invested into have fund managers that are buying and selling stocks with the target to beat the market on your behalf.
At the end of the day, if your money is being actively managed, you aren’t enjoying the benefits of passive investing.
# 4 Passive Investments In Passive Funds, That Are Actively Traded
This is a slightly more complicated situation that even more experienced investors may not realise deviates from passive investing.
Like in the previous example, you invest passively. This time, you invest into funds that are passively managed as well. Sounds great, right? You’re not out of the woods yet.
Those passive funds may be actively managed. This happens when you invest in broad country, region or sector-based ETFs that are being actively bought and sold. This may happen in a situation where you invest via robo-advisory or other fund of funds type of investments. Oftentimes, this active trading behaviour is explained as rebalancing your portfolio or adjusted based on algorithms that the firm is using.
In this method, even though you’re investing the right way and in the right kinds of investments, you may still be considered an active investor.
What Should I Do To Ensure I’m A Passive Investor?
Without trying to make it sound too simplistic, embarking on a passive investing strategy should involve very little thinking. You can invest in ETFs that comprise the strongest stocks in a country, region or sector.
Ensure these ETFs are just mimicking an index, and not trying to beat the market with an active manager. Also, you need to take emotions out of the equation. This means ignoring noise in the market, but not being oblivious to fundamental changes in companies, especially if you’re investing in individual blue-chip stocks via a monthly investment plan.
If you’re investing into robo-advisory or passive funds, make sure they’re actually passively managing your funds, rather than actively buying and selling or adjusting your portfolios.
You still need to review your investments periodically, especially if you’ve invested in individual stocks via a monthly investment plan. If these investments still hold the same fundamentals and investment thesis that made them blue-chip investments, continue holding. If they are truly fundamentally altered, consider rebalancing your portfolio.