Passive Investing: Explained

Index Funds

In a nutshell:

Passive investing is a strategy that can be used by anyone, with minimal time and knowledge required, to deliver returns similar to that of the stock market, to compound wealth over time.

Key points:

  • Anyone can invest passively.
  • Investing into an index fund is a passive investment.
  • Pros include: low cost, simple, long term.
  • Cons include: being unable to beat the market, boring.
  • Choosing Vanguard as an investing platform, and the FTSE Global All Cap Fund with 0.24% fees, is a viable, passive, long term strategy.

Content:

  1. What is Passive Investing?
  2. Pros and Cons of Passive Investing
  3. Setting up a Passive Investing Strategy

What is Passive Investing?

Actively managed funds try to beat the market return by picking stocks each year. However, due to the inability of these active funds to regularly and reliably beat the markets return, index funds have became popular over the last decade.

Passive investing is an investment strategy that tracks an index, such as the FTSE 100 or S&P 500. Due to the low maintenance of tracking an index, the fees are very low, especially when compared to an actively managed fund. The objective of an index fund is to deliver the same returns of the market.

Index funds, whilst still being exposed to market volatility, over the long run, should go up as markets go up over time. For an average person, who doesn’t care much for the stock market, and hasn’t got much time on their hands, index investing is an optimal way to increase wealth over time.

Market timing is also not important, as the idea is that the same amount of money will be invested into an index fund at a set interval throughout the year, so over the long term there are benefits from a lower cost basis from market booms and recessions.

Pros and Cons of Passive Investing

Pros:

  • Cost
  • Simple
  • Long term

Cost: Investing in an index fund has much lower fees than investing in an active fund. Consequently, you are able to compound as much of your money as possible over a long period of time.  

Simple: There is an initial sunk cost of time and effort to open a brokerage account and choose a fund. But once this is done, you can choose to never do anything again.  You can invest into your chosen fund at set intervals every week, month or year. This takes the emotion out of investing as you will be investing automatically, and also means you do not need to concern yourself with daily fluctuations in the market.

Long term: History tells us that the stock market, over the long term, rises by about 7-10% a year. This allows money to be compounded over decades to increase the wealth of people invested in the stock market.

Cons:

  • Cannot beat the market
  • Boring

Cannot beat the market: Index funds provide returns similar to that of the market. Due to this it is a given that an individual cannot generate returns better than the market if they are just investing in index funds.

Boring: Passive investing is a boring strategy. Although, it is important to note that boring strategies can, and do, work, and boring companies are some of the best to invest in – Peter Lynch particularly likes boring companies, as he is able to discover them before Wall Street does. If you have an interest for researching companies then simply just investing into an index fund is likely to be boring, and so you may want to allocate some money towards picking individual stocks.

Passive Investing Strategy

You will need to choose a platform to invest on, and then a product to invest into (a global tracker, for example).  This can be done tax-free in the UK, making use of a Stocks and Shares ISA (see our previous blog post).

Vanguard offers low-fee, index fund investing, with a platform fee of 0.15% per year. You will then need to choose an index fund to invest in. If you believe in the UK economy, or emerging markets, for example, you can choose to invest in an index fund that tracks these respectively. As a starting point, a good idea is to invest in a global tracker, this will track the global economy – such as Vanguard’s FTSE Global All Cap Index Fund.

Next, you will want to set up a set interval for investing. For example, automatically investing £100 on the same day each month.

That’s it. You have chosen an investing platform, a passive investing product – an index fund, and have now started compounding your wealth over your lifetime!

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