Is passive investing right for me?
How many individuals are weighing the potential advantages over active investing.
By Derek Wolf, Founder | Senior Field Specialist
Last updated: May 23, 2022 | Article published: May 23,, 2022
Back before 1975, investing meant actively buying and holding stocks. It was not until 1976, that the then CEO of The Vanguard Group John C. Bogle pioneered the index fund. This allowed individual investors to buy shares that mirrored the S&P 500. The index fund revolutionized investing for the
everyday investor by making it more accessible.
So what is active vs passive investing. First we must understand what they are and all that they entail.
In active investing, you buy and sell individual stocks. You do this either directly through a trading platform or through a fund manager. When trading stocks you must be willing to put forth the time and effort into researching companies and their stocks all while actively managing each asset in your portfolio.
In a passive investing strategy, you invest in a mutual fund. These funds give you the option to invest in across multiple industries across the stock market and mirror what they are doing. This allows you to invest into multiple stocks and diversify your portfolio allowing you to mitigate risk compared to placing it all on one company. This is a passive approach where you invest in the fund for the long term compared to managing portfolio daily as you would with active investing.
Now some of the pros associated with passive investing is the lowers fees as you are not actively buying and selling individual stocks. So with fewer transactions, it may cost you less. You also have less maintenance on your portfolio. You are not spending a significant amount of time tracking stocks,
charts, and the news in an attempt to predict the market. Then you will have returns over the long
haul. The S&P Indices versus Active data revealed more than a 90% of Large-Cap actively managed funds underperformed the S&P 500 over a ten-year period. Finally you may have tax efficiency as if you hold stocks and assets over the long term without frequently buying and selling you could end up paying less in capital gains taxes. With a lower trading volume compared to active trading, you may have fewer fees and less tax consequences.
But what are some of the cons associated with passive investing?
You will have a limited choice as you do not have the option of handpicking stocks or deselecting an individual stock within the fund. There are also unpredictable returns as not all passive funds are created equal, and since they seek to mirror the market, it’s possible your investment may not gain above-market returns.
Now with all that being said; historically speaking, though past performance is not a guarantee of future returns, stocks have risen on average 7 out of every 10 years, according to data from Dimensional Fund Advisor. So you can see that investing into the long haul could potentially be a more favorable return.
What are some strategies for the long haul in passive investing?
Based upon the performance data from previous years, there is no one individual or professional manager that has had the ability to buy and sell at the right times consistently. You are more than likely better off focusing on a more longer term strategy. There are numerous assets classes and sectors within the market in any given year. There is no pattern or past performance that can guarantee favorable future results. With this in mind, it is best to design your portfolio for your risk tolerance and goals in as a diversified position as possible.
In conclusion, with regards to if an individual should partake in passive investing; there are multiple factors to consider. With potentially lowers fees, less times spent managing, and the possible tax savings, you must account for your overall financial plan and what your goals are.
*Investing strategies, such as asset allocation, diversification or rebalancing, do not ensure or guarantee better performance and cannot eliminate the risk of investment losses. All investments have inherent risks, including loss of principal. There are no guarantees that a portfolio employing these or any other strategy will outperform a portfolio that does not engage in such strategies. Past performance does not guarantee future results.