What is passive investing?

Individuals looking to grow their money have many options at their disposal. For example, real estate is often cited as a wise investment, as the value of property has historically increased by a significant margin over the course of a lifetime, providing a substantial return all the while fulfilling the basic need for housing that everyone has. But buying property is not the only potentially lucrative long-term investment strategy.

A small percentage of investors may have the skill, savvy and iron stomach to excel with short-term investments. But most people feel more comfortable with less risky, long-term investments. For such individuals, one strategy worth considering is passive investing.

What is passive investing?

Passive investing utilizes a buy-and-hold approach to gradually build wealth. Short-term fluctuations in stock prices do not affect passive investors, as one of the principles of passive investing is that markets will post positive results over time. So passive investors do not react with alarm when prices temporarily drop, even if they drop by a considerable margin.

What is an index fund?

Index funds are one of the most recognizable forms of passive investing. The investment experts at Vanguard, the company that first started offering index funds, note that an index fund contains a preselected collection of hundreds or even thousands of stocks or bonds or a combination of both. The theory behind this is that, even if one stock or bond is performing poorly, another within the portfolio is doing well, thus minimizing losses and saving investors the time and effort of tracking, as well as buying and selling, individual stocks or bonds.

Diversification and passive investing

Conventional investment wisdom has long touted the benefits of diversification when investing. When investors put all of their eggs in one basket, they could then lose all of their investments if the value of that investment goes south. As previously noted, index funds include a collection of stocks, bonds or both, thus providing investors with sufficient diversification that can serve as something akin to a safety net when the values of certain stocks or bonds within the portfolio dip. Though no investment strategy can claim it is free of risk, passive investing through a vehicle such as an index fund can be a low-risk way to grow wealth over time.

Criticisms of passive investing

The investment resource Investopedia cites lack of flexibility and smaller potential returns as two significant drawbacks of passive investing. Passive investment funds are limited to a predetermined set of investments that don’t often vary, if at all. That might be not sit well with individuals who prefer a more active and flexible approach to investing.

Big returns also are less likely with passive investment funds, as these funds are designed to track the market, not beat it by a wide margin. Individuals with long-term investment strategies likely won’t be turned off by this, though those looking for bigger rewards (which, notably, carry bigger risk) may be underwhelmed by the returns on passive funds.

Passive investing is a sound investment strategy for individuals who want to grow their wealth over the long haul.