Passive investing is a long-term wealth-building strategy all investors should know — here’s how it works

passive investing

Summary List Placement

If you can’t beat ’em, join ’em. 

That, in a nutshell, is the mantra of passive investing. This popular investment strategy doesn’t try to outperform or “time” the stock market with a constant stream of trades, as other strategies do. Instead, passive investing believes the secret to boosting returns is by doing as little buying and selling as possible. 

Passive investing, also known as passive management, may be laissez-faire, but it’s not lazy. Its thoughtful, time-honored philosophy holds that, while the stock market does experience drops and bumps, it inevitably rises over the long hauls. 

So, rather than try to outsmart it, the best course is to mirror the market in your portfolio — usually with investments based on indexes of stocks — and then sit back and enjoy the ride. 

Simple to understand and easy to execute, passive investing has become the go-to approach for many investors. Here’s how to join them.

What is passive investing?

The essence of passive investing is a buy-and-hold strategy, a long-term approach in which investors don’t trade much. Instead, they purchase and then hang onto a diversified portfolio of assets — usually based on a broad, market-weighted index, like the S&P 500 or the Dow Jones Industrial Average. The goal is to replicate the financial index performance overall — to match, not beat, the market.  

Perhaps the most common passive investing approach is to buy an index fund tied to the market. These sorts of funds are often known as passively managed, or passive, funds. The underlying holdings in passive funds can be stocks, bonds, or other assets — whatever makes up the index being tracked. 

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If the index replaces some of the companies included in it, then the index fund automatically adjusts its holdings, selling the old stocks and purchasing the new ones. Thus, investors profit by staying the course and benefiting from the market increases that happen over time. 

Typically, index funds specialize in such areas as equities, fixed income, commodities, currencies, or real estate. Choosing different types of funds depends on the investor’s desire for income or growth, risk tolerance, and needs to balance the portfolio. 

Fixed-income bond funds generally act as a counterbalance to growth stocks’ volatility, for example, while foreign currency funds can help provide a hedge against the depreciation of the US dollar. 

Key features of passive investing

The ultimate goal of passive investing is to build wealth gradually, as opposed to making a quick killing. Key characteristics of a passive strategy include:

Optimistic outlook. The core principle underlying passive investing strategies is that investors can count on the stock market going up over the long haul. By mirroring the market, a portfolio will appreciate along with it.

Low costs. Thanks to its slow and steady approach and lack of frequent trading, transaction costs (commissions, etc.) are low with a passive strategy. While management fees charged by funds are unavoidable, most ETFs — the passive investor’s vehicle of choice — keep charges well below 1%.

Diversified holdings. Passive strategies also inherently provide investors …read more

Source:: Businessinsider – Finance


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