Acting in a passive way whilst investing may sound a bit odd, and yet passivity and investing can be quite compatible. Passive investing could even be the investment approach for you.
It’s about following the whole market
Despite what the name might suggest, passive investing isn’t about doing nothing, per se. A passive investing strategy is to simply follow the ups and downs of global market indices, like the FTSE100, and let the market determine your returns. Put simply, in passive investing, if the market goes up, the value of your investment will increase. And vice versa, if the market falls, so will your investment. Passive investors typically favour steady growth over the long-term.
A hamper of investments
How do you ‘follow’ a whole market? Well, it’s less tricky than it sounds, thanks to passive investment funds, also known as index tracker funds. They’re like buying a hamper, full of tasty investments selected by experts to work together and achieve a specific goal. Some will track a single market, whilst others might contain investments from multiple markets, like Asia or Europe. Investment funds don’t necessarily just comprise of stocks and shares either, they can also contain all sorts of things, like bonds, property, and commodities (metal, corn, oil, or agriculture), if your not sure of the difference between the main asset types, you can find a description of the most popular in our blog; What are you invested in?. Picking individual investments can require a great deal of time and extensive research. If you already struggle to decide which shampoo to use, imagine having to choose between millions of complex financial products. Funds are here to help, as they already contain a selection of investments. And if you’re not confident selecting your own funds, a robo-advisor like Wealthify can select them for you and adjust the mix regularly to make sure it’s performing.
Eggs in different baskets
You can choose to buy one passive fund and track a single market index, which still means being invested in hundreds of companies. You could also opt for a plethora of funds and diversify your portfolio of investments even further. Spreading your money around, (a practice known as diversification) is widely recognised as a great way to mitigate your risk and can help you achieve consistent returns over the longer term. The more diversified your portfolio, the more your risk is spread, since one or two poorly-performing markets may only affect a small portion of your invested money.
It’s a buy and hold approach
Passive investing is also known as ‘buy-and-hold’ strategy. In other words, instead of chopping and changing your portfolio, which can be expensive and time-consuming, you tend to hold onto your investments longer. Investing should be seen as a long-term strategy. Research shows that over recent decades people who invested in the FTSE 100 for 10 years at a time had a 95% chance of making money.1 Think of your investments like aging wine, the longer you keep them, the tastier the outcome could potentially be.
1 This is money, Feb 2016 - http://www.thisismoney.co.uk/money/diyinvesting/article-3452668/A-10-year-investment-FTSE-100-95-success-rate-past-two-decades.html
It’s tried and tested
The alternative to passive investing is active investing, where people pick specific stocks and other investments in an attempt to outsmart the market. Opinion is divided about this strategy. Imagine, a person trying to cram all of the market prices, profit and loss data into their head – it’s virtually impossible since things move every second. Active investors have to rely on a certain amount of experience and gut feel when picking their investments, and rates of success vary. CNBC reports that most active fund managers haven’t beaten the S&P500 over 15 years2. However, active investing shouldn’t be completely overlooked – if you have a few million spare, some hedge funds claim to deliver regular double-digit growth, but if you don’t it could make sense to go with the flow and adopt a ‘wait and see’ approach.
2 CNBC, April 2017 - https://www.cnbc.com/2017/04/12/bad-times-for-active-managers-almost-none-have-beaten-the-market-over-the-past-15-years.html
Please remember, investments can go down in value and you could receive back less than invested.