The passive investment follows a buy and holds strategy. Securities for passive investment are bought with the intention of holding on it for a long time. There are various passive investment options like bonds, fixed deposits, real estate and so on.
What is Passive Investment?
When it comes to investing your money, there are two options, active investment, and passive investment. The investment strategy you choose depends on your risk tolerance level and investment goals.
Active investing involves investing in buying securities for a low value and selling it at a higher price.
Passive investment focuses on only high returns over a longer time-period with minimum buying and selling activities.
In other words, passive investment follows the buy and hold technique. The investment fund is bought with the idea of holding on to it for many years. Investors choose these investment options for wealth creation under the assumption market yields more in a longer time-period.
The passive investment aims at maximizing returns, in the long run, keeping the portfolio at a low level. There is no frequent trading here thereby avoiding fees and other charges.
The active investment aims to outperform the market. The fund managers continuously monitor and analyze the market for active management of mutual funds.
On the other hand, passive investment follows the trend of the market and goes along investing in funds in proportion to the market performance. The objective here is to duplicate the market and not outperform it.
It is a myth that only active investment yields more returns than a passive investment. With the right strategies, passive investment can also reap rewards.
Benefits of Passive Investment
It is simpler to track the stock indexes like nifty and Sensex if its spread out over a long period. The indices are predictable unlike that of active investment funds. There is enough time to analyze and gaze into past performances of the capital market.
It is important to maintain a diverse portfolio for successful investing, and passive investment helps in this regard especially through indexing. Index funds help spread out the risk in holding all or some of the securities.
Since there is continuous monitoring of market involved in active investments, it is more expensive for the investor. He must pay higher fees to the fund manager.
Index funds aim to target an index or benchmark rather than only seeking winners. This helps to avoid constant buying and selling securities. These funds have lower operating expenses and lower fees than active funds. Index funds are an easy way to invest in a chosen market as all we have to do track the index. There is no need to look for any managers to monitor or choose an investment theme.
Outperforming the stock index in active investment is difficult: Inactive marketing, the asset prices reflect all market information. As the market gains knowledge and is well-informed, it is shown in stock prices.
Active investors concentrate on smaller portfolios with a few securities. Hence in the broader market perspective, the chances of underperforming are quite high.
Since passive investment closely follows the market and matches its performance, there is no need of much analysis and decision making. There are relatively fewer investments to monitor abs lower costs to be paid by the investor.
Passive investment involves little buying and selling and hence, lesser planning. Being a long-term investment, it is more reliable and predictable. This investment strategy is for people looking for low-risk investments and not for big capital gains.
Transparency: In passive investment index funds, it is always clear what assets are being managed.
Tax Benefits: The buy and hold strategy of passive funds don’t result in a huge capital gain tax.
Passive Investment Strategies
Widening Out Investment: With this strategy, you spread out your investment in various companies rather than only aiming at well-performing ones. You choose a particular market and invest in all the highly capitalized companies in that market.
With this strategy, you can leverage the overall growth of the market rather than depending on one particular company.
For instance, rather than investing only in the stock market, you can consider bonds, real estate, debt, and equities. In this scenario, you have a strong portfolio for getting returns and growth even if the stock market fails.
Re-investment: The other strategy in passive investment is moving your money around. You take the money from selling high-value stocks and invest in other stocks that are underperforming. The result will be that you will earn a higher return than the stock market performance.
Begin early and invest often: Since passive income takes time to be generated, it is better to get started earlier and make regular investments.
Passive Investment Options
There are many lucrative passive investment options. These include:
Certificates of Deposit(CD): Earlier CD’s used to deliver a good rate of return but in current times, CD’s don’t provide anything over 2.5%. But the best feature of CD’s is that no minimum investment is needed in the form of income or net worth like many other investments. CD’s can be opened at any local bank for the desired duration.
Fixed Income/ Bonds:
Bond prices are only going up as the interest rates are coming down. Bonds are a safe defence option for an investment portfolio. If you hold on to a fixed income bond till maturity, you are bound to get your payments and principal back. And there are plenty of investment bonds to choose from like municipal or corporate bonds. The only disadvantage of a bond investment is that if interest rates go higher, the value of bonds will reduce.
For those who are good at property manager, real estate is a great passive investment opportunity. It has the benefits of appreciation of principal and rental value. To make money out of passive investment from real estate, you must rent out property; it could be your house, a room in your house or elsewhere.
The idea of peer to peer lending is to help denied borrowers to get loans at an interest rate lower than that of financial institutions. In this form of investment, the rate of risk increases with the lending rate.
Investment in large-cap dividend companies is another way of generating passive income. Many blue-chip companies continuously demonstrate an increase in dividend payouts each year. Telecom, financial and utility companies form the major dividend-paying companies.
Technology, biotech and internet companies, on the other hand, do not pay a high dividend as they reinvest their earnings back into their company stock.
Investing in Private Equity:
If you choose the right option, private equity investment is the best source of passive income. Equity and hedge funds, real estate, private company funds are the most liquid source of private investments.
Work on your business idea:
If you have a great business idea and entrepreneurial skills, you can create your product that can generate a steady source of income. You can use the internet to connect and sell your product.
Passive Investments Risks.
Passive investment is dependent on total market risk. Since index funds track the whole market, whenever the stock market or bond prices reduce, even the index funds also reduce. Lack of flexibility is another risk of index funds. Generally, managers of index funds do not adopt any defence mechanisms like reduction in share value even if he thinks stock prices are going to reduce.
There are some performances constraints on passive investment index funds because they aim to provide returns that steadily track the benchmark index rather than look out only the performance. Index funds usually do not beat the index and yield lesser returns due to operating costs.
To sum up, following the benefits and the risks involved in passive investments, there are ideal techniques to follow. Buy a huge collection of long-term holdings across different industries, market sizes, and even countries. However bad these holdings perform, never sell them. Deposit fresh money into the brokerage account by reinvesting the dividends.
Keep expenditure as minimal as possible. Passive investment strategies are becoming popular in spite of the risk factor. The savings make up for the risky investments. They are a safer option than being an active player in the market, offering a slow but steady rate of growth.