Passive Investing – Overview, Advantages & Disadvantages

1. What is Passive Investing?:

Passive investing is a widely preferred investing strategy by long term investors because it aims at extracting maximum returns from the market without the hassle of frequent trading in the markets. It in turn helps in reducing the incurred charges in the form of taxes and brokerage with frequent trading. The ultimate goal of passive investing in to generate wealth gradually.

It is often referred to as buy and hold strategy which means that you are buying a security and aim to keep it for the long term. Passive traders do not seek to profit from short term market fluctuations. The investors use this strategy to replicate the performance of the market by having a well-diversified portfolio, which if done individually, would need extensive research and knowledge.

Outperforming the market is not an easy task and therefore passive managers try to match the performance of market or sectors. The introduction of index funds has made it further easier to achieve returns which are in line with the markets. The introduction of exchange traded funds or ETFs which usually track the benchmark indices of the market has simplified the process even further because it allows the investors to trade index funds as though they were stocks.

2. Benefits of Passive Investing:

For successful investing diversification is the key and passive investing using indexing is the best way to achieve optimum diversification. Some of the key benefits of passive investing are as follows:.

• Ultra-low fees: There is no one who is selecting or picking the stocks. Thus, the oversight is very economic. The index which is used as the benchmark is usually followed by passive funds.
• Transparency: The assets included in any index fund are always very clear.
• Tax Efficiency: The buy and hold strategy which is involved in passive investing does not attracts massive capital gain tax or other taxes.
• Simplicity: Investing and owning an index or a group of indices is a lot easier to implement and comprehend when compared to any dynamic strategy which requires constant research and planning.

2. Drawbacks of Passive Investing

Passive investing is also subject to market risks because the index funds involved track the performance of the entire market. As a result, if there is a fall in the prices of overall stock market or bond market, the index funds will also fall. Also, there is a lack of flexibility with passive investing. Some of the weaknesses or drawbacks of passive investing include:

• Very Limited: There is hardly any variance with passive funds because they are limited to a predetermined set of investments or specific index. As a result, the investor is locked in those holdings.
• Smaller Potential Returns: Passive funds can never beat the markets, no matter what because the core holdings of a passive investment are locked in to track the market. Rarely a passive fund may beat the market by a little margin, but it will never extract big returns, for which the fund managers crave until the market itself booms.

While passive investing can be a very good investment strategy for maximizing your returns with minimal trading, it has its own pros and cons as well. Therefore, it is not necessary that it will be fit for your investing style. It is better to have an in-depth knowledge about your investment style before opting for any investment strategy. In case you are confused, you should opt for the services of a SEBI registered investment advisor who will analyze a number of parameters to find your investment style and also get your risk appetite by conducting your risk profile analysis. They will then suggest the best investment strategy for your needs based on all the pointers. One should always remember that the markets are full of risks and one should not step in any investment strategy or trading without proper knowledge and research.