Many people have the perception that investing is a complex activity that requires intimate knowledge of financial instruments and markets. Surprisingly though, anyone who can read and grasp basic mathematics can achieve lucrative returns from investing. Like many beginners, I assumed I had to partake in active investing and timing the market to build wealth. This does not have to be the case for beginner investors. I’m here to share tips on passive investing for beginner investors.
What is Passive Investing?
Passive investing (or index-style investing) is a long-term investing strategy that aims to maximize returns by minimizing buying and selling. The basis of this type of investing strategy is that even though there is short-term volatility the market inevitably rises over the long run.
Typically, passive investing is carried out using index funds. The objective of index funds is to match the returns of the market NOT beat the market. The passive strategy is to buy into a diversified index fund and hold that position for the long-term. Fund managers will, from time to time, buy and sell stocks that make-up the index fund to ensure the fund reflects index behavior as much as possible. However, the investors themselves do not partake in this.
There are many pros and cons to passive investing that beginner investors should be aware of:
Pros of Passive Investing
- Low Cost
- Low Risk
- Tax Management
Cons of Passive Investing
- Susceptible to Market Risk
- No Flexibility
- Return is Limited To Index Performance
- Operational Costs
- No Hedging to Minimize Losses
Passive Investing Strategies For Beginner Investors
- Be Aware of Fees – Before you decide to invest, be cognizant of the fees you’ll be expected to pay. While a passive investing strategy results in less fees than an active strategy, these are costs that will lower your returns.
- Mutual funds vs ETFs – When many people think about passive investing, they automatically think mutual funds. This is not the only way to engage in passive investing. Exchange traded funds are simply mutual funds that have been packaged and traded like a stock on the stock market. Just like the price of a stock is derived from the underlying business, the price of an ETF is derived from the value of the underlying fund. Please let me know if you would like to learn more about ETFs. I’d be happy to write about it!
- Explore Niche Markets – A con of passive investing is it can be rigid. Beginner investors can get around this by exploring funds that target different regions, industries or asset types (e.g. real estate or bonds). There are even mutual funds that target different investing objectives. For example, there are funds that target capital growth while there are others that target dividend income.
- Automate Investments – Automating your investment contributions adds another layer of simplicity to a passive investing strategy. Over time, with little effort you’ll realize your wealth is increasing and you’re achieving your investment goals.
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