There’s been a long debate between active investing and passive investing on which is the better option for both new and seasoned investors.
But saying one is better than the other will largely depend on your financial capabilities, risk appetite, and current investment portfolio. It’s helpful to understand the differences between both options, how to utilize them for your portfolio, and the importance of having a diversified portfolio.
Common misconceptions about passive investing are that it yields low returns, has an underwhelming performance, and is becoming less popular. These aren’t true — passive investing, when done right, can outperform most active investments.
Passive investing has also been growing in popularity and now controls nearly half of the US stock market. It is definitely in its growth stage as the number of passive investments is expected to continue rising well after 2025.
In this article, we’ll discuss a little more about what passive investing is, the various examples of passive investments, and the top three benefits of passive investing.
What Is Passive Investing?
Passive investing is a type of investment strategy that aims to maximize your returns while minimizing your need for constant buying and selling. This investment method also aims to avoid any unnecessary fees and limits performance monitoring that’s common with active investing.
This investing method is also sometimes known as the buy-and-hold strategy, which means you’re buying an investment for long-term ownership. Those who prefer passive investing rarely seek short-term profits and are not keen on seeing price fluctuations and constant market monitoring.
Investment managers who favor passive investing believe that it’s almost impossible or difficult to out-smart and out-pace the everchanging market. It’s also difficult to constantly try to match the market.
Passive investing tries to replicate the market performance, usually from extensive research of historical performance, and construct a diversified portfolio consisting of single stocks. The introduction of the index funds in the 1970s made achieving returns with this method much easier.
The introduction of exchange-traded funds, or ETF, in the 1990s, made the process of achieving returns much simpler. This is because it allowed investors to trade index funds as though they were stocks.
What’s An Example of Passive Investing?
There are many examples, with the most common being index funds. Index funds are ETFs linked to a market index or mutual funds that are passively managed.
This means you’ll have lower management costs, lower turnover rates, and higher tax-efficient than other investments. Besides index funds, what are the other forms of passive investments?
Real estate is also an alternative example of passive investing. Although the real estate market has its own share of fluctuations, it’s still one of the preferred choices for investors looking for long-term profits. This could be from rental charges or from real estate investment trusts (REIT).
A newer form is a peer-to-peer lending (P2P), sometimes also known as crowdfunding. This is where you’ll lend money to a person or business and receive returns based on the person or the business’ performance. Once you’ve invested money into P2P, there’s almost nothing you have to do while you wait for your returns.
Dividend stocks are one of the simplest examples. As public companies generate profits, a portion of those earnings is then funneled back to investors in the form of dividends. You can then decide to either pocket the cash or reinvest that money.
Top 3 Benefits of Passive Investing
Maintaining a portfolio that has several diversifications is important to ensure the success of your investments. Passive investments are a great way to achieve that diversification, which also comes with many benefits. There are three main benefits to passive investing:
- Low expenses
- Low yearly taxes
- Easy to understand
1. Low Expenses
As you don’t need anyone to pick out or monitor your stocks, your expenses in maintaining your passive investments are incredibly low when compared to active investments. With passive investing, you have the option of being completely in charge of your portfolio or hire a passive investment manager. No matter your choice, the fees are still considerably low.
2. Low Yearly Taxes
As a buy-and-hold strategy, this means your investments typically will not have large capital gains every year. This can greatly reduce your yearly investment-related taxes, saving you more money.
3. Easy to Understand
Owning indexes is considerably a lot easier to understand and manage than a dynamic investment that requires constant monitoring and research. It’s as easy as selecting an index you want to hold. The index strategy will help you determine when to buy or sell.
For example, the strategy of the S&P 500 Index is to own a selection of the top 500 companies in the US. Every year, companies that fall out of the top 500 list will be sold and those that made it another year into the top 500 will be purchased.
With passive investing, you eliminate the stress of constantly trying to outsmart the market. You earn and lose whatever the market earns and loses. This is recommended if you want to minimize fees and don’t mind the long wait time.
How should you maintain a well-diversified portfolio to maximize profits on your investments? Passive investing may be the answer. Whether via indexing or real estate investments, passive investing gives you many options to diversify your portfolio.
This type of investing is also known for its significantly lower fees, lower yearly taxes, and for its simplicity, making it a top strategy for new and experienced investors. Unlike active investing, you won’t need to worry about yearly large capital gains that can increase your taxes.
With passive investing, your investments can sit without interference and without needing your attention. While it’s easy to check your portfolio and get into the hype of the fluctuating market, that isn’t the point of passive investing. All you have to do with passive investment is pick what you’d like to invest in, sit back and let your money grow. Passive investing has seen great growth and will continue to see growth in the next years.
Are you interested in learning more about your passive investment options? Book an appointment with us to see how we can help you.