Intro to Passive Investing

November 9, 2021

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When you hear the term "passive investing," you might wonder if this means you can just invest money and walk away.

There is some truth to this; once you have an account set up, passive investing can feel pretty breezy in the sense that you don’t have to research individual stocks, track their prices or make sudden moves.

However, just because you can be hands-off doesn’t mean there aren’t a few things you may want to keep in mind, like your investing goals, fees and your investing time horizon.

And, since this is investing: You need to think about risk. Regardless of whether you choose active or passive investing (we briefly summarize active investing a little lower down) investing is a bit of a gamble because there’s always the possibility that you could lose money.

Still sound good? Great. We’ll take you through some passive investing basics to consider before you decide to go all in.

What is passive investing?

Passive investing is not a get-rich-quick scheme. Instead, it’s an approach for investing for the long term that may include making – wait for it – relatively few trades.

Passive investing typically comes with lower fees than active investing

In other words, this approach is not like the movies where you see people waiting for the right moment to pounce and make a trade. With passive investing you generally don’t need to track individual stocks or bonds because you’re typically invested in an array of holdings through something like an index or ETF fund (we cover this in a section below).

One of the ideas behind passive investing is to stick with your “investment variety pack” for an extended period of time. (How this approach has worked out in the past is addressed later.)

What is active investing?

As you can probably gather from the name, active investing is a bit more hands-on. Active investors keep a watchful eye on the market and research things like market trends, company fundamentals and economic forecasts to help determine how they’ll move their money into (or out of) different investments.

Just like active investing, you can find passive investing options that let you invest in funds that align with certain values.

Yes, it’s possible to invest actively on your own. But if market volatility isn't your second language, you may want to consider using the pros. Fund managers can oversee active investments.

Generally, they navigate market changes by watching and adjusting invested assets based on what they believe will bring the greatest potential returns given market conditions based on the level of risk they are willing to take on. But remember, even the best portfolio managers can’t predict the future or always outsmart the market with their picks.

What does a passive investment portfolio look like?

When you follow a passive investment strategy, you usually invest in either an index mutual fund or exchange traded fund, commonly known as an ETF.

Here’s an overview of the two typical options:

Index mutual funds are essentially a collection of stocks or bonds. They are set up to track the performance of a market index, such as the S&P 500, Russell 2000 Index or the Wilshire 5000 Total Market Index. Some funds simply buy all the stocks or bonds in the index they are tracking, while others pick and choose a representative example from the index.
ETFs contain a collection of assets, such as stocks, bonds or other types of securities into a single fund. ETFs and mutual funds are similar. But unlike mutual funds which only trade once per day, ETFs can be traded like stocks on an exchange, that is, throughout the day.

The pros and cons of passive investing

By now, you probably understand that passive investing tends to be less involved compared to active investing. (Again, the name gives it away!) In addition to typically requiring less effort, some of the other benefits of passive investing are:

Historical performance: Should you really just watch your investments go along for the ride as they track the market? History isn’t a guarantee that things won’t change in the future, but past performance indicates that this strategy has worked and passive investments have performed just as well, if not better, than active ones.
Low fees: Passive investing typically comes with lower fees than active investing (since you don’t need as much oversight from a fund manager).
Transparency: You can see exactly which assets are included in a fund.

Some of the possible downsides of passive investing:

It’s for the long-term: The buy-and-hold approach of passive investing is premised on investing your money for an extended period.
Less control over individual assets: Because you’re investing in a collection of securities, you can’t choose to sell companies or sectors within your selection that are underperforming or become too risky.
You shouldn’t expect to outperform the market: Passive investing generally tracks the market, which means your investments will mirror what’s happening. Beating the market generally requires an active approach. (That said, investing doesn’t have to be an either/or situation; you can do both.)

Important! Even though you don’t need to track individual investments with passive investing, you may want to check in on things like your asset allocation and make modifications based on factors like your timeline and cash flow. You may also want to check in with an advisor, or even do periodic research on your own so you have a sense of whether market trends have shifted and if you may want to move money in (or out of) different types of investments.

A little more about ETF and Mutual Fund costs

We mentioned fees above, but what do they cover? Some back-of-the house account work and some fund fees. Here’s an example of what you may come across:

Passive mutual fund fees: Management fees, total annual fund operating expenses and other expenses.
ETF costs: ETF fees cover expenses for manager salaries, custodial expenses and marketing costs. You will also want to look for expense ratios, which are expressed as a percentage to be deducted from your managed assets. For example, if your expense ratio is 0.50, then your fund would deduct half of one percent, or $5 of every $1,000 you have invested. You’ll be able to find this information in the fund’s prospectus.

Should I consider passive investing?

A passive investing strategy might work for you if:

You're OK with keeping your money invested over a longer period
You're interested in fairly hands-off approach to investing
You're comfortable riding out the waves of the market

Just like active investing, you can find passive investing options that let you invest in funds that align with certain values. Many mutual funds and ETFs, for example, focus on investing in companies that follow certain environmental, social and governance (ESG) factors or that try to bring about a positive impact through their work.

Ready to get started – Wait, there’s a little bit more

So you know the mechanics – nice! – now there’s the question of who you want to do the passive investing for you.

We’ll be fast. You could:

Do it yourself: If you want to invest in a particular passive mutual fund, you can open an account directly with the fund company. Another option is to open a brokerage account that allows you to buy and sell shares of a fund you’re interested in, plus any other fund options available on the platform.
Work with a professional: A financial advisor can help guide you through your options. When you work with a financial advisor, they will generally ask you about your long-term goals and structure a plan that can help meet your needs, comfort level and timeline. Note that advisors generally charge incremental fees for their services, which can vary from advisor to advisor.
Use a robo-advisor: A robo-advisor is a digital platform that provides online investing solutions, typically with little human oversight. Most robo-advisors offer passive investing strategies made up of mutual funds or ETFs to build portfolios. A robo-advisor will also ask you questions about your financial goals and overall situation. Robos may also rebalance your portfolio so its stays aligned with your target asset allocation.

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