Passive is a term opposite to active. Passive means absence of speedy action .i.e. slow action.
Active investors after monitoring the Income statement, Balance sheet, like each and every companies Finance statements, Analyses the sectors performance connected with those companies, countries Economy, considering various factors select and pick the stocks.
But Passive investors are opposite to those activities. While the countries economy is better, the complete stock market seems to be good. While performing like that, why we can’t choose the best of buying the Entire indexes of Nifty (or) Sensex ! Why to worry about small things. Efficient market theory explains that other than the market nothing can earn more. Those who are accepting the concept , passive investing is best suited.
Definition of 'passive investing'
An investment strategy involving limited ongoing buying and selling actions. Passive investors will purchase investments with the intention of long-term appreciation and limited maintenance.
Also known as a buy-and-hold or couch potato strategy, passive investing requires good initial research, patience and a well diversified portfolio.
Unlike active investors, passive investors buy a security and typically don't actively attempt to profit from short-term price fluctuations. Passive investors instead rely on their belief that in the long term the investment will be profitable.
What is passive investing ?
Passive investing is a strategy focused on achieving long-term appreciation of portfolio values with limited day-to-day management of the portfolio itself.
Passive investing - often referred to as evidence-based investing, or indexing - seeks to replicate the performance of the market by investing to a pre-determined strategy which focuses on:
a) keeping costs low by avoiding unnecessary trading
b) diversifying across a wide set of asset classes - holding all of the market and avoiding over-exposure in any particular sector
c) taking the long term view - markets can do better in some years and worse in others, but passive investors understand that markets are efficient and operate on the basis of all known information. Long term, you cannot beat the market.
How It Works / Example:
A passive investor is one who limits on-going buying and selling activities. A passive investor purchases securities, builds a portfolio, and generally holds the portfolio for the long term.
Passive investors usually do not actively buy and sell as prices change in the market. The general investment philosophy of passive investors is that their portfolios will grow with the long-term growth of the market.
Generally investing in Index Funds and E.T.F’s is denoted as passive Investing. For example Nifty and Sensex. Like that in India several indexes are found, not in India, but in various several Foreign countries also investments are increasing.
In this manner functioning Funds and E.T.F,s based on a specific index , under that index containing various stocks invested in the same ratio. While investing like that “Tracking Error” may occur a small value. In that index altered or percentage changed those index tracking funds may also be altered.
Investing in indexes are done by most passive investors. But some pick and buy the stocks in appropriate time and then forget considering as Assets. In Long term they believe definitely those purchased stocks may produce large returns. Based in this criteria the stocks purchased may not give unfortunate results. Good profits has yielded. This is also a passive investing method.
Some others buy some specific stocks in fixed intervals ( like S.I.P ) They never mind of those stock prices fluctuations. They are also passive investors.
Peoples like Warren Buffet, advice those unknown about stock market can invest in Index fund a passive investing method.
Logic of Passive Investing !
If the stock market is not efficient, should you be an active investor? If stock prices are sometimes wrong, then someone with the skill and expertise required to identify these market inefficiencies might do well. Consider other skill based activities, for example, a free throw competition in basketball. Suppose that you get a dollar for every shot out of ten that goes through the basket, and there is no fee to play. This is a conservative assumption with regard to the stock market because there are in fact "fees" to active investing, like transaction costs and tax inefficiencies, which we will discuss later. Like any analogy, the free-throw competition has its strengths and weaknesses, but one important characteristic of this analogy is that most players in the game will make at least some money. This is a critical characteristic, because the stock market is a "positive sum" game in the sense that investors do, on average, enjoy returns greater than the time value of their money. The compounded annual return on U.S. large-cap stocks since 1926 has been about 11 percent, as reported by Ibbotson Associates. This long-run return, in excess of the time value of money (interest rates), is a reward for risk and represents the new societal wealth that is created by the investment of capital in plant and equipment, employee coordination and training, and technological research. In contrast, sports betting and other forms of gambling are "zero-sum" games. A zero-sum game is one in which the profits of all players sum to zero.
Under the no-fee-to-play condition, you should play the free throw game (and perhaps the stock market) even if your self-assessed basketball talent is marginal. But what if we add the twist that, instead of actively participating in the game, you can take the average score of those that do? Passive investing is just such a twist in the investing game, because a total market index fund contains all stocks, and all stocks have to be held by someone. This often ignored but unassailable fact has important implications. Chief among them is that in the absence of the costs of active investing, the index return over any time period must be the weighted-average performance of all active investors during that time period. Thus, while investing in general is a positive-sum game, active investing is a zero sum game with respect to the alternative of indexing. One active investor's ability to outperform the index has to come at the expense of another investor's underperformance. Unlike the children in Garrison Keillor's Lake Wobegone, all investors cannot be above average.
If you were in the basketball free throw game, and were given the alternative to sit out and take the average score of the other players, what would you do? Your first thought might be to look around and make a guess at how your basketball skills compare to everyone else's. If you think your skills are lower than average (and remember, that must be half of everyone) then the smart thing to do is to not play: to take the average. But what if everyone else takes this approach? Then only those in the top-half of the skill pool will choose to play, and the average score you get by sitting on the sidelines will be based on only the top-half players. From this more rational perspective, you should only choose to play if your skills are in the top 25 percent of all potential players. But what if everyone takes this more rational perspective? Eventually no one but the very best player shoots, and everyone else gets his or her score. If everyone were perfectly rational, and not subject to overconfidence, there would be very few active investors. Thus overconfidence, perhaps the most pervasive of all investor irrationalities, is critical to market liquidity. We will return to the role of overconfidence in the marketplace toward the end of this discussion, but it should be clear that at least half, and perhaps more, of all active investors would be better off indexing.
Why It Matters:
Passive investors rely on slow, steady growth in the market. The passive investor builds his portfolio based on an allocation of assets to match his tolerance for risk. After selecting investments for his portfolio, the passive investor will buy and then hold onto his portfolio for the long term.
PASSIVE INVESTING WORKS IN ALL MARKETS !
Market efficiency is one of the more controversial ideas in finance. Many academics believe that the stock market is a nearly perfect pricing mechanism for companies. If the market is “efficient” then stocks are correctly priced according to all available information. If stocks are correctly priced according to all available information then there is simply no point in doing any kind of analysis, out performance would be a matter of luck and not skill.
The active funds industry is based on the idea that stocks are not efficiently priced. Analysts search for undiscovered opportunities, ranging from the “value” approach where one is essentially a bargain hunter, through to the “growth” approach where one looks for companies with superior profit prospects. Whether value or growth, or a combination, or something else entirely, active managers justify their existence with the idea that a skilled investor can identify superior opportunities and can outperform the market.
I am often asked about where I sit in arguments about market efficiency and whether I feel stocks are correctly priced or not. This is, apparently, very important, why would one adopt a passive approach if there were all of those mispriced stocks out there, allowing skilled investors to outperform?
The answer is that I personally believe the market is highly inefficient and agree that skilled investors can outperform the market. However, that doesn’t mean everyone should invest actively. The key factor to note is the idea that trading and active investment is inherently a zero-sum game compared with the market.
WHY MANY LIKE PASSIVE INVESTING ?
In passive investing , the greatest plus point is the lowest fund expense. In India actively managed many funds “Expense Ratio” is maximum 2.25 % per year. At the same time several index funds & E.T.F’s “Expense Ratio” is maximum 1 %. The balance amount of expense ratio based on long term may produce high gains for investors. Buying an index may get diversification. Tension is reduced. If the market is either lowering or highering your investment also fluctuate similarly.
Moreover passive investors are long term investors. So that Capital gains tax is not required to pay. Short term investors have to pay 15 % as capital gains tax in profit. All are saved. Apart from this paying low brokerage. Being a passive investor there is no need to buy / sell routinely. No need to worry about Fund Managers performance.
WHAT ARE ALL THE NEGATIVE FACTORS AFFECTING PASSIVE INVESTING ?
In index participation, of some stocks / sectors would not be liked by us. But buying the total index which includes the disliked sectors also. Learning all those, Indian stock market has not still performed in maximum efficiency. Due to these reasons, active investors had gained much more gain. Even though the gains received does not equal but not even nears the index return is the unfold truth.
Some very big Mutual Fund schemes / E.T.F,s functioning in America are based in passive investing method. The size of those passive investing market is alone several 100 billion dollars. In world level, S&P based (SP – DR,s – Spiders) M.C.S.I. Index based ( I Shares ) Nasdaq 100 based QQQQ, hang Seng based TRAHK – Tracks are the popular passive investing methods.
The entire History / subject about passive investing are all O.K.
WHAT IS PASSIVE MANAGEMENT :-
Passive management (also called passive investing) is a financial strategy in which an investor (or a fund manager) invests in accordance with a pre-determined strategy that doesn't entail any forecasting (e.g., any use of market timing or stock picking would not qualify as passive management).
Passive investment management makes no attempt to distinguish attractive from unattractive securities, or forecast securities prices, or time markets and market sectors. Passive managers invest in broad sectors of the market, called asset classes or indexes, and, like active investors, want to make a profit, but accept the average returns various asset classes produce. Passive investors make little or no use of the information active investors seek out. Instead, they allocate assets based upon long-term historical data delineating probable asset class risks and returns, diversify widely within and across asset classes, and maintain allocations long-term through periodic rebalancing of asset classes.
The idea is to minimize investing fees and to avoid the adverse consequences of failing to correctly anticipate the future. The most popular method is to mimic the performance of an externally specified index. Retail investors typically do this by buying one or more 'index funds'.By tracking an index, an investment portfolio typically gets good diversification, low turnover (good for keeping down internal transaction costs), and extremely low management fees. With low management fees, an investor in such a fund would have higher returns than a similar fund with similar investments but higher management fees and/or turnover/transaction costs.
Passive management is most common on the equity market, where index funds track a stock market index, but it is becoming more common in other investment types, including bonds, commodities and hedge funds. Today, there is a plethora of market indices in the world, and thousands of different index funds tracking many of them.
One of the largest equity mutual funds, the Vanguard 500, is a passive management fund. The two firms with the largest amounts of money under management, Barclays Global Investors and State Street Corp., primarily engage in passive management strategies.
Which would be suitable for me either passive or active is the million dollar question ?
Passive investing based on which index ( For example Nifty50 stocks based E.T.F ) those index levels highering, the gains depending upon the price hike , the same gains if possible, insufficient time sharing persons, complete zero about stock market, zero risk persons, able to enter immediately in compulsion, for all the above persons, passive investing is the best method.
Able to manage more time, knowing all the facts about stock market, able to earn money beating the index , risk taking persons are all active investing types.
Passive Investing Is the Solution
If you can’t pay someone to beat the market for you, and you can’t do it yourself, what options do you have? That’s where passive investing comes in.
Passive investing is investing with the knowledge that beating the market for a long period of time is nearly impossible. Instead, passive investors simply attempt to match market returns as closely as possible while keeping fees, taxes, market timing and fund selection mistakes to a minimum.
The most common way to invest passively is through an index fund. An index fund is a type of mutual fund that invests with the goal of matching the performance of an index, which tracks the performance of a market. Index funds accomplish this by investing in all the stocks of a particular index based on market capitalization.
For example, if you invest in an S&P 500 index fund, that fund will take your money and invest it in 500 of the largest companies in the United States based on their market capitalization. The largest portion of your money would go towards buying stock in the largest U.S. companies, such as Exxon, Apple, IBM, and on down the list, all the way to the smallest company (in which very little of your money would be invested). The beauty of this structure is that it allows the index fund to almost perfectly match the index (or market) while making very few trades.
Because very few trades have to be made after the initial purchase, transaction fees for the fund are almost zero. In addition, taxes are much lower because there is almost no turnover. Most importantly, passive managers don’t have to be paid large salaries to run the fund because it follows a set of simple trading rules. Therefore, the expense ratios of these funds can be extremely low, even as low as one tenth of a percent.
Passive investors also don’t lose any investment return to market timing mistakes because they know that attempting to beat the market by jumping in and out will only hurt them. And they certainly don’t attempt to switch between funds, because they already own the entire market in their single index fund!
Basically, once an investor knows that it is impossible to beat the market in the long run, there is no reason for them to be anything other than a purely passive investor.
Customizing Passive Investing to Suit Your Needs !
Passive investing works for everyone, from young professionals with high-risk appetites to retirees simply looking to draw a steady income from their retirement savings.
The key to making passive investing work for any individual is to determine the correct asset allocation for his or her situation. Asset allocation is simply the mix of investment types that make up your portfolio. For example, a high risk, high return passive portfolio may be made up of mostly a U.S. stock index fund and a foreign stock index fund, with very little in a U.S. bond index fund. On the other hand, a low risk passive portfolio would be made up of mostly a bond index fund with much less in stock index funds.
By adjusting the asset allocation of their portfolio, investors can create a passive strategy that gives them the perfect balance of risk and return, no matter what their situation is.
So, Why Isn’t Everyone a Passive Investor?
Passive investing is not a new idea. The first index fund was created in 1975, and it still exists today as one of the largest funds in the world. The principles of passive investing are supported by hundreds of academic studies, and multiple Nobel Prizes in Economics have been awarded for research findings that detail the superiority of passive investing. You can even read what some of these Nobel Prize recipients have to say about passive investing here on a website. So, why do more than 90% of individual investors in the United States still attempt to beat the market by investing actively?
The fact is, most of the public’s investing knowledge comes from the mainstream financial media and investment professionals (such as brokers) because they have the financial means to get their messages out to the public. However, those financial means can also create very large conflicts of interest.
It is much easier for Wall Street to make money by selling the more expensive investment vehicles used by active investors than to make a living educating people about the advantages of passive investing. A broker’s business would quickly fail if he told every person that walked into his office that they would be better off as a passive investor. And the financial media would run out of well-paying advertisers, not to mention interested viewers, if they only ran story after story about the simple superiority of passive investing.
Active investors after monitoring the Income statement, Balance sheet, like each and every companies Finance statements, Analyses the sectors performance connected with those companies, countries Economy, considering various factors select and pick the stocks.
But Passive investors are opposite to those activities. While the countries economy is better, the complete stock market seems to be good. While performing like that, why we can’t choose the best of buying the Entire indexes of Nifty (or) Sensex ! Why to worry about small things. Efficient market theory explains that other than the market nothing can earn more. Those who are accepting the concept , passive investing is best suited.
Definition of 'passive investing'
An investment strategy involving limited ongoing buying and selling actions. Passive investors will purchase investments with the intention of long-term appreciation and limited maintenance.
Also known as a buy-and-hold or couch potato strategy, passive investing requires good initial research, patience and a well diversified portfolio.
Unlike active investors, passive investors buy a security and typically don't actively attempt to profit from short-term price fluctuations. Passive investors instead rely on their belief that in the long term the investment will be profitable.
What is passive investing ?
Passive investing is a strategy focused on achieving long-term appreciation of portfolio values with limited day-to-day management of the portfolio itself.
Passive investing - often referred to as evidence-based investing, or indexing - seeks to replicate the performance of the market by investing to a pre-determined strategy which focuses on:
a) keeping costs low by avoiding unnecessary trading
b) diversifying across a wide set of asset classes - holding all of the market and avoiding over-exposure in any particular sector
c) taking the long term view - markets can do better in some years and worse in others, but passive investors understand that markets are efficient and operate on the basis of all known information. Long term, you cannot beat the market.
How It Works / Example:
A passive investor is one who limits on-going buying and selling activities. A passive investor purchases securities, builds a portfolio, and generally holds the portfolio for the long term.
Passive investors usually do not actively buy and sell as prices change in the market. The general investment philosophy of passive investors is that their portfolios will grow with the long-term growth of the market.
Generally investing in Index Funds and E.T.F’s is denoted as passive Investing. For example Nifty and Sensex. Like that in India several indexes are found, not in India, but in various several Foreign countries also investments are increasing.
In this manner functioning Funds and E.T.F,s based on a specific index , under that index containing various stocks invested in the same ratio. While investing like that “Tracking Error” may occur a small value. In that index altered or percentage changed those index tracking funds may also be altered.
Investing in indexes are done by most passive investors. But some pick and buy the stocks in appropriate time and then forget considering as Assets. In Long term they believe definitely those purchased stocks may produce large returns. Based in this criteria the stocks purchased may not give unfortunate results. Good profits has yielded. This is also a passive investing method.
Some others buy some specific stocks in fixed intervals ( like S.I.P ) They never mind of those stock prices fluctuations. They are also passive investors.
Peoples like Warren Buffet, advice those unknown about stock market can invest in Index fund a passive investing method.
Logic of Passive Investing !
If the stock market is not efficient, should you be an active investor? If stock prices are sometimes wrong, then someone with the skill and expertise required to identify these market inefficiencies might do well. Consider other skill based activities, for example, a free throw competition in basketball. Suppose that you get a dollar for every shot out of ten that goes through the basket, and there is no fee to play. This is a conservative assumption with regard to the stock market because there are in fact "fees" to active investing, like transaction costs and tax inefficiencies, which we will discuss later. Like any analogy, the free-throw competition has its strengths and weaknesses, but one important characteristic of this analogy is that most players in the game will make at least some money. This is a critical characteristic, because the stock market is a "positive sum" game in the sense that investors do, on average, enjoy returns greater than the time value of their money. The compounded annual return on U.S. large-cap stocks since 1926 has been about 11 percent, as reported by Ibbotson Associates. This long-run return, in excess of the time value of money (interest rates), is a reward for risk and represents the new societal wealth that is created by the investment of capital in plant and equipment, employee coordination and training, and technological research. In contrast, sports betting and other forms of gambling are "zero-sum" games. A zero-sum game is one in which the profits of all players sum to zero.
Under the no-fee-to-play condition, you should play the free throw game (and perhaps the stock market) even if your self-assessed basketball talent is marginal. But what if we add the twist that, instead of actively participating in the game, you can take the average score of those that do? Passive investing is just such a twist in the investing game, because a total market index fund contains all stocks, and all stocks have to be held by someone. This often ignored but unassailable fact has important implications. Chief among them is that in the absence of the costs of active investing, the index return over any time period must be the weighted-average performance of all active investors during that time period. Thus, while investing in general is a positive-sum game, active investing is a zero sum game with respect to the alternative of indexing. One active investor's ability to outperform the index has to come at the expense of another investor's underperformance. Unlike the children in Garrison Keillor's Lake Wobegone, all investors cannot be above average.
If you were in the basketball free throw game, and were given the alternative to sit out and take the average score of the other players, what would you do? Your first thought might be to look around and make a guess at how your basketball skills compare to everyone else's. If you think your skills are lower than average (and remember, that must be half of everyone) then the smart thing to do is to not play: to take the average. But what if everyone else takes this approach? Then only those in the top-half of the skill pool will choose to play, and the average score you get by sitting on the sidelines will be based on only the top-half players. From this more rational perspective, you should only choose to play if your skills are in the top 25 percent of all potential players. But what if everyone takes this more rational perspective? Eventually no one but the very best player shoots, and everyone else gets his or her score. If everyone were perfectly rational, and not subject to overconfidence, there would be very few active investors. Thus overconfidence, perhaps the most pervasive of all investor irrationalities, is critical to market liquidity. We will return to the role of overconfidence in the marketplace toward the end of this discussion, but it should be clear that at least half, and perhaps more, of all active investors would be better off indexing.
Why It Matters:
Passive investors rely on slow, steady growth in the market. The passive investor builds his portfolio based on an allocation of assets to match his tolerance for risk. After selecting investments for his portfolio, the passive investor will buy and then hold onto his portfolio for the long term.
PASSIVE INVESTING WORKS IN ALL MARKETS !
Market efficiency is one of the more controversial ideas in finance. Many academics believe that the stock market is a nearly perfect pricing mechanism for companies. If the market is “efficient” then stocks are correctly priced according to all available information. If stocks are correctly priced according to all available information then there is simply no point in doing any kind of analysis, out performance would be a matter of luck and not skill.
The active funds industry is based on the idea that stocks are not efficiently priced. Analysts search for undiscovered opportunities, ranging from the “value” approach where one is essentially a bargain hunter, through to the “growth” approach where one looks for companies with superior profit prospects. Whether value or growth, or a combination, or something else entirely, active managers justify their existence with the idea that a skilled investor can identify superior opportunities and can outperform the market.
I am often asked about where I sit in arguments about market efficiency and whether I feel stocks are correctly priced or not. This is, apparently, very important, why would one adopt a passive approach if there were all of those mispriced stocks out there, allowing skilled investors to outperform?
The answer is that I personally believe the market is highly inefficient and agree that skilled investors can outperform the market. However, that doesn’t mean everyone should invest actively. The key factor to note is the idea that trading and active investment is inherently a zero-sum game compared with the market.
WHY MANY LIKE PASSIVE INVESTING ?
In passive investing , the greatest plus point is the lowest fund expense. In India actively managed many funds “Expense Ratio” is maximum 2.25 % per year. At the same time several index funds & E.T.F’s “Expense Ratio” is maximum 1 %. The balance amount of expense ratio based on long term may produce high gains for investors. Buying an index may get diversification. Tension is reduced. If the market is either lowering or highering your investment also fluctuate similarly.
Moreover passive investors are long term investors. So that Capital gains tax is not required to pay. Short term investors have to pay 15 % as capital gains tax in profit. All are saved. Apart from this paying low brokerage. Being a passive investor there is no need to buy / sell routinely. No need to worry about Fund Managers performance.
WHAT ARE ALL THE NEGATIVE FACTORS AFFECTING PASSIVE INVESTING ?
In index participation, of some stocks / sectors would not be liked by us. But buying the total index which includes the disliked sectors also. Learning all those, Indian stock market has not still performed in maximum efficiency. Due to these reasons, active investors had gained much more gain. Even though the gains received does not equal but not even nears the index return is the unfold truth.
Some very big Mutual Fund schemes / E.T.F,s functioning in America are based in passive investing method. The size of those passive investing market is alone several 100 billion dollars. In world level, S&P based (SP – DR,s – Spiders) M.C.S.I. Index based ( I Shares ) Nasdaq 100 based QQQQ, hang Seng based TRAHK – Tracks are the popular passive investing methods.
The entire History / subject about passive investing are all O.K.
WHAT IS PASSIVE MANAGEMENT :-
Passive management (also called passive investing) is a financial strategy in which an investor (or a fund manager) invests in accordance with a pre-determined strategy that doesn't entail any forecasting (e.g., any use of market timing or stock picking would not qualify as passive management).
Passive investment management makes no attempt to distinguish attractive from unattractive securities, or forecast securities prices, or time markets and market sectors. Passive managers invest in broad sectors of the market, called asset classes or indexes, and, like active investors, want to make a profit, but accept the average returns various asset classes produce. Passive investors make little or no use of the information active investors seek out. Instead, they allocate assets based upon long-term historical data delineating probable asset class risks and returns, diversify widely within and across asset classes, and maintain allocations long-term through periodic rebalancing of asset classes.
The idea is to minimize investing fees and to avoid the adverse consequences of failing to correctly anticipate the future. The most popular method is to mimic the performance of an externally specified index. Retail investors typically do this by buying one or more 'index funds'.By tracking an index, an investment portfolio typically gets good diversification, low turnover (good for keeping down internal transaction costs), and extremely low management fees. With low management fees, an investor in such a fund would have higher returns than a similar fund with similar investments but higher management fees and/or turnover/transaction costs.
Passive management is most common on the equity market, where index funds track a stock market index, but it is becoming more common in other investment types, including bonds, commodities and hedge funds. Today, there is a plethora of market indices in the world, and thousands of different index funds tracking many of them.
One of the largest equity mutual funds, the Vanguard 500, is a passive management fund. The two firms with the largest amounts of money under management, Barclays Global Investors and State Street Corp., primarily engage in passive management strategies.
Which would be suitable for me either passive or active is the million dollar question ?
Passive investing based on which index ( For example Nifty50 stocks based E.T.F ) those index levels highering, the gains depending upon the price hike , the same gains if possible, insufficient time sharing persons, complete zero about stock market, zero risk persons, able to enter immediately in compulsion, for all the above persons, passive investing is the best method.
Able to manage more time, knowing all the facts about stock market, able to earn money beating the index , risk taking persons are all active investing types.
Passive Investing Is the Solution
If you can’t pay someone to beat the market for you, and you can’t do it yourself, what options do you have? That’s where passive investing comes in.
Passive investing is investing with the knowledge that beating the market for a long period of time is nearly impossible. Instead, passive investors simply attempt to match market returns as closely as possible while keeping fees, taxes, market timing and fund selection mistakes to a minimum.
The most common way to invest passively is through an index fund. An index fund is a type of mutual fund that invests with the goal of matching the performance of an index, which tracks the performance of a market. Index funds accomplish this by investing in all the stocks of a particular index based on market capitalization.
For example, if you invest in an S&P 500 index fund, that fund will take your money and invest it in 500 of the largest companies in the United States based on their market capitalization. The largest portion of your money would go towards buying stock in the largest U.S. companies, such as Exxon, Apple, IBM, and on down the list, all the way to the smallest company (in which very little of your money would be invested). The beauty of this structure is that it allows the index fund to almost perfectly match the index (or market) while making very few trades.
Because very few trades have to be made after the initial purchase, transaction fees for the fund are almost zero. In addition, taxes are much lower because there is almost no turnover. Most importantly, passive managers don’t have to be paid large salaries to run the fund because it follows a set of simple trading rules. Therefore, the expense ratios of these funds can be extremely low, even as low as one tenth of a percent.
Passive investors also don’t lose any investment return to market timing mistakes because they know that attempting to beat the market by jumping in and out will only hurt them. And they certainly don’t attempt to switch between funds, because they already own the entire market in their single index fund!
Basically, once an investor knows that it is impossible to beat the market in the long run, there is no reason for them to be anything other than a purely passive investor.
Customizing Passive Investing to Suit Your Needs !
Passive investing works for everyone, from young professionals with high-risk appetites to retirees simply looking to draw a steady income from their retirement savings.
The key to making passive investing work for any individual is to determine the correct asset allocation for his or her situation. Asset allocation is simply the mix of investment types that make up your portfolio. For example, a high risk, high return passive portfolio may be made up of mostly a U.S. stock index fund and a foreign stock index fund, with very little in a U.S. bond index fund. On the other hand, a low risk passive portfolio would be made up of mostly a bond index fund with much less in stock index funds.
By adjusting the asset allocation of their portfolio, investors can create a passive strategy that gives them the perfect balance of risk and return, no matter what their situation is.
So, Why Isn’t Everyone a Passive Investor?
Passive investing is not a new idea. The first index fund was created in 1975, and it still exists today as one of the largest funds in the world. The principles of passive investing are supported by hundreds of academic studies, and multiple Nobel Prizes in Economics have been awarded for research findings that detail the superiority of passive investing. You can even read what some of these Nobel Prize recipients have to say about passive investing here on a website. So, why do more than 90% of individual investors in the United States still attempt to beat the market by investing actively?
The fact is, most of the public’s investing knowledge comes from the mainstream financial media and investment professionals (such as brokers) because they have the financial means to get their messages out to the public. However, those financial means can also create very large conflicts of interest.
It is much easier for Wall Street to make money by selling the more expensive investment vehicles used by active investors than to make a living educating people about the advantages of passive investing. A broker’s business would quickly fail if he told every person that walked into his office that they would be better off as a passive investor. And the financial media would run out of well-paying advertisers, not to mention interested viewers, if they only ran story after story about the simple superiority of passive investing.
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