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Tune in to CNBC, and you will be inundated with all different types of investing strategies, each of which is supposedly better than the next.
Believe the hype, and you will be convinced it is in your interest to monitor the market at all times, investing as soon as potential opportunities arise.
This active investing approach is widely encouraged, yet there are significant advantages to passive investing.
“It’s not about timing the market, but about time in the market.”
What Is Passive Investing?
The definition of passive investing is exactly as it sounds. Passive investing is a comparably low-risk approach to investing in which an investor’s money is parked in relatively safe investment vehicles such as mutual funds and ETFsfor a long period of time.
Passive investing aims to match the gains of a specific sector or the entire stock market while also outpacing inflation.
How Does Passive Investing Work?
Passive investing is relatively easy. You can passively invest on your own or create an account that is passively managed through an automated system, like a robo-advisor.
An experienced financial industry professional oversees such automated trades to ensure they are prudent and logical in the investor’s financial interest.
Most passive investment holdings are centered on stocks in ETFs or mutual funds instead of specific stocks. Investing in entire funds reduces risk by spreading capital across a group of stocks instead of individual companies.
Holdings and allocations are changed as necessary, though trading is infrequent compared to active investing.
>> More: Best Robo-Advisors
Passive Investing Example
Consider a busy parent with little time to follow the stock market.
This individual can greatly benefit from investing in an index fund like VOO or a mutual fund. That provides exposure to hundreds of stocks as opposed to just one or two.
The thematic ETF known as VanEck Vectors Video Gaming and eSports is one of the more popular ETFs to hit the market in recent years.
Traded under the symbol of ESPO, this ETF is currently trading at $67.70. A passive investor can easily invest around a thousand dollars in the ESPO ETF by scooping up about 15 shares and holding them for decades.
Such a position provides exposure to all the top publicly traded players in the eSports industry.
This segment of the gaming industry is likely to grow exponentially in the years and decades ahead, meaning investors in ESPO can confidently park their money in the ETF and passively manage it without heightened risk resulting from a massive investment in a single stock.
Pros and Cons of Passive Investing
- Simplicity: Groups of stocks are bought, and in-depth analysis of individual stocks is unnecessary.
- Lower Fees: Fewer trades are made, meaning the fund manager/overseer plays less of a role.
- Easy to Monitor: Passive Investors make few changes throughout the year. Typically, they employ dollar-cost averagingand buy stockseach month regardless of price.
- Set it and forget it: You can focus your attention on your family, job, or hobbies rather than micromanaging your investments.
- Lover Overall Risk: Investing dollars are parked in entire groups of stocks and indexes instead of comparably risky individual stocks like Snowflake (SNOW), Zoom (ZM), or CRISPR (CRSP)
- Potentially Lower Returns: Less risk is taken through the ownership of indexes rather than individual stocks.
- Less Flexibility: The fund is passively managed, meaning there won’t be opportunities to quickly pivot to options that require timely reactions to market dynamics, news, etc.
Brief History of Passive Investing: Where Did It Start?
This approach to investing started in 1975. Though passive investing did not reach a mainstream tipping point in the 70s or enter the mainstream media’s lexicon until years later, it is now the investing strategy most recommended by advisors.
The first-ever index fund was created by John C. Bogle, the CEO of The Vanguard Group.
This fund empowered retail investors to invest in the ETF known as the Vanguard 500 without excessive fees or commissions.
What Do Passive Investors Invest In?
- Mutual Funds: A collection of stocks designed for risk mitigation with ample diversification.
- Exchange-Traded Funds (ETFs): Put simply, ETFs are stocks that represent entire indexes and are traded with shares similar to those of stocks.
- Index Funds:Index Funds track an index or benchmark instead of attempting to handpick individual winners.
- Target Date Funds: Funds are meant to provide a simplified approach to investing with an asset allocation mix that transitions from aggressive to conservative as the target date nears.
Why Is Passive Investing Popular?
The rise of passive investing is attributable to the inherent fear of losing hard-earned money due to excessive risk, greed, and potential market declines.
Even if the market tanks, those who diversify their risk by investing in ETFs or mutual funds through passive investing can still retain the majority of their wealth.
Furthermore, passive investing has fewer fees than active investing and requires less effort.
Is Passive Investing Safe?
Passive investing is safe. You will sleep well at night knowing your money is working hard for you through passive investing. This is a low-risk approach to investing.
Is It Hard to Be a Passive Investor?
No, anyone can be a passive investor. It requires little knowledge and expertise. Moreover, robo-advisors and brokers make it easy to compare ETFs and create financial goals.
You can passively invest on your own after studying the market and current events. Alternatively, you can passively invest through a fund that is automated and overseen by a financial professional.
Is Warren Buffett a Passive Investor?
Yes and no. Buffet has gone on record as a proponent of passive investing. Buffett endorses passive, low-cost investment vehicles like ETFs.
Tips for Passive Investing
#1. Play the Long-Term Game
Passive investing will take time to generate gains as it spreads your money out across several funds, stocks, and investment vehicles.
Patience is clearly a virtue in the context of passive investing.
#2. Keep It Simple
Do not attempt to understand the idiosyncrasies of every single ETF and mutual fund. Focus on a collection of such funds, gradually expand your focus, and don’t overcomplicate things.
#3. Buy and Hold Is Your Best Friend
History shows the market will move higher as time progresses. Be patient and hold onto your passive income investments, and they are likely to increase in value over time.
#4. Trust the Process
Your portfolio might decrease soon after you begin passive investing. Recognize the fact that risk is inherent to every investing approach, continue to trust the process, and resist the temptation to constantly check your portfolio.
Bottom Line: What Is Passive Investing?
If you don’t want to subject your earnings to a comparably high level of risk, if you detest paying investing-related fees, or if you prefer that your money be spread out across groups of stocks, passive investing is tailor-made for you.
This approach to investing can gradually expand your wealth without being exposed to unnecessary risk.
If you don’t believe you can time the market, or if you do not have the risk tolerance associated with individual stocks, do not hesitate to consult with a financial advisor, financial planner, or Certified Financial Planner for more guidance pertaining to passive investing.