Investing is the act of allocating funds. However, what a lot of people don’t understand about investing is that just allocating funds into an investment plan is not enough. In fact, investments themselves are not a monolith. One of the types of investing is passive investing. The phrase “slow and steady wins the race” best exemplifies passive investing. It is a long-term strategy for building wealth by buying securities mirroring the market indices and holding them long term. This strategy can help in lowering the risk because you’re investing in a mix of asset classes and industries and not an individual stock.
How does it work?
This strategy tries to avoid things like fees. The main goal of passive investing is to help you to accumulate wealth gradually. Also referred to as the buy-and-hold strategy, passive investors don’t seek profits from short-term price fluctuations or market timing. The underlying assumption of this type of strategy is that the market posts positive results over time. Investors here try to match market or sector performance. Investors using this strategy attempt to replicate the market performance by constructing well-diversified portfolios of single stocks. However, it is important to note that if the action is done individually, the investor would be expected to carry out extensive research.
Are there any examples of passive investing?
One of the common examples of passive investing is index funds.
What are index funds?
Index funds are a type of mutual fund in which a portfolio is constructed to match or track the components of a financial market index. Index mutual funds are known for exposing an investor to things like low operating expenses and low portfolio turnover. These funds follow their benchmark index regardless of the state of the markets.
What are its key features?
Listed below are some of the salient features of an index mutual fund:
- These funds are known for following a passive investment strategy.
- These funds are a portfolio of stocks or bonds that are designed to mimic the composition and performance of a financial market index.
- One of their appealing features for investors is having lower expenses and fees.
- They seek to match the risk and the income of the market. It is done based on the theory that in the long term, the market will outperform any single investment.
How do they work?
After opting to invest in an index mutual fund, your money is pooled with other investors. After taking money, the fund manager allocates it to instruments that make up the index such as stocks and bonds. While an investor may or may not invest in every component of an index, they aim to get an appropriate sample of every piece to effectively track the index performance over time.
What type of investors are they ideal for?
The investment decision in a mutual fund solely depends on things like the investors’ risk preferences and their investment goals. These funds are suitable for investors who are risk-averse and expect predictable returns. Plus, these funds do not require extensive tracking. For example, in case you wish to participate in equities but don’t wish to take risks associated with actively managed equity mutual funds, you can choose a Sensex or Nifty index fund. These funds will give you returns matching the performance that a particular index sees. However, if you wish to earn market-beating returns, then you can opt for actively managed funds.
The portfolio of index funds consists of blue-chip stocks i.e., these are the stocks of well-established companies that possess an excellent track record. Because of this, they are less susceptible to market fluctuations and therefore are known for offering stability, something that will attract investors seeking regular and steady inflow of extra income.
Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.