What is Passive Investing?

Malcolm Tatum

Passive investing is a collective term that is used to describe strategies for investing that require less active involvement on the part of the investor. The classic approach to this type of investing activity is to structure an investment portfolio to more or less follow the performance of a particular index. However, other buying and selling actions, such as the use of a buy and hold strategy, can also be considered passive investing.

Businessman with a briefcase
Businessman with a briefcase

There are two benefits that are usually identified by investors who favor the concept of passive investing. The first has to do with the fact that proper index tracking means that selling and buying actions will take place on a basis that follows the market trend. This means the investor does not have to spend a great deal of time analyzing various indicators and attempting to project future market movements. In theory, following the general market trends will create a situation where the investor always rides the crest of the market, only making trades when and as price fluctuations and other factors that influence the market index call for some type of action.

The second benefit to passive investing is that the investor does not necessarily have to be well-versed in the world of trading in order to make use of these methods. Many of them are designed to make it possible for the investor to set up a series of trading activity in advance, then simply let those transactions take place when the time is right. For example, with a buy and hold strategy, the investor purchases a number of shares at a certain price, holds them until they appreciate to a specific amount per unit, then sells the shares, realizing the desired return. Once the process is set in motion, the investor does not have to be concerned with monitoring stock activity, or even understanding what else is happening in the market.

While some investors have success with passive investing, these wait-and-see strategies do carry some degree of risk. Index tracking does not necessarily account for the possibility of unforeseen circumstances, such as the occurrence of a natural disaster, a significant shift in the political balance of power in certain countries, or some other factor that directly impacts the financial stability of the market. Investors who rely solely on this method have as much potential to sustain losses as they do to make a profit.

For this reason, many financial analysts recommend using a varied approach to investments, rather than relying on passive investing or any other approach alone. This creates a situation where a portion of the holdings in the portfolio can simply follow the index tracking and perform well, but the investor may still pick up on clues that something significant is about to impact the market. By being more active in managing other holdings, the investor is in a position to identify those previously unforeseen factors and act before money is on those holdings managed with a passive strategy.

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