Investing in the stock market might seem like a complex money-making method, but anyone can reap the benefits of passive investing. Passive investing is a form of long-term investing that requires a little bit of research upfront, little maintenance, and the potential for impressive rewards in the long run. It’s much simpler than active trading, but there are still some things passive investors should know.
What is passive investing?
Also called passive management, passive investing involves buying stocks with the intent to hold them for an extended period. It can be a helpful option for anyone planning for long-term goals, like retirement or a child’s college fund.
Passive investing is not the right option for monetary goals of less than 10 years. The nature of the market is that the longer a stock is, it may rise and fall in the short term, but over time worthwhile stocks will see overall uptrends.
Long term investments can take form in three different ways: mutual funds, exchange-traded funds, and index funds.
example: Fidelity 500 Index Fund (FXAIX)
Investing in a mutual fund means contributing money to a pool and claiming part ownership of stocks, bonds, or securities. Professional fund managers will handle the investment from there, resulting in very little maintenance from the investor.
This ease of investing will cost you, though. Mutual funds often incur more fees and debts than other long-term investments. There also might be a minimum investment required. Still, mutual funds are a reliable option for anyone interested in passive investing.
Exchange-traded funds (ETFs)
example: Vanguard S&P 500
Like mutual funds, ETFs are a collection of several stocks or bonds that are within the same index. The main difference is that investors can buy and sell an ETF directly through the stock exchange. The stocks in an ETF will track a specific industry, so investors can keep a diversified portfolio of their chosen sector (like technology, raw materials, or currency). Generally, ETFs will also incur fewer fees and taxes over time than mutual funds.
ETFs and mutual funds both allocate assets and diversify a portfolio with ease, making them both reliable options for passive investing.
example: NASDAQ or S&P
Another easy way to have a diversified passive investment is through an index fund, which is a collection of stocks and bonds. This is still considered a diversified portfolio because it is an investment of various companies.
What’s in the index rarely changes, so you’re investing in a specific collection of stocks and bonds. With index investments, passive investors can also buy a percentage of stock without the need to buy a full share.
There are very few fees involved with investing in index funds, making it a great option for passive investors. Index funds also take the guesswork out of diversification and keep the portfolio growing.
How to be a successful passive investor
Anyone can become a passive investor with just a bit of resource, but there are a few things to keep in mind:
1. Don’t expect to have complete control
Part of the beauty of passive investments is the lack of hands-on maintenance, but some people may not enjoy the lack of involvement. This is a set-it-and-forget-it sort of investment that will pay off in the long run.
2. Give it time
Passive investing is not a get-rich-quick strategy, but a chance to let your money grow in the long term. Think of it as planting a tree. You’re not going to get fruit in the first season, but think of how sweet it will be to eat from a tree you planted years ago.
3. Don’t get emotional
The stock market is a rollercoaster. You will undoubtedly see peaks and valleys over time, but don’t fear. Uncertainty is expected in the short term, but if history proves that the market always bounces back. Don’t worry about getting off the ride when you hit a dip (considered a bear market). An upswing (or bull market) is bound to arrive in the long run.
Is passive investing better than active?
Although all investing comes with risks, passive investing is less of a dangerous game than short term trading. Short-term trading requires a lot more involvement in analyzing individual stocks and bonds, as well as identifying short-term trends in the market. Passive investing takes a lot of the sweat and guesswork out. Passively investing also saves money on fees and heartache from a volatile market.