The term "passive investment" has developed something of a reputation in recent years. It's increasingly recognized as a way for time-poor or non-investment-skilled individuals to get a foothold on the investment ladder and potentially start making some profit.
But what exactly is passive investment? Who is it suitable for - and who does it not suit? What do you stand to gain by following a passive investment program, and what do you have to sacrifice? This blog post will explore the pros and cons of passive investment, and it will also explore some of the strategies you can use to execute it.
What is passive investment?
Passive investment is an investment strategy that doesn't require active, repeated involvement in the day-to-day trading decisions that your portfolio makes. Instead, you allow your portfolio to build and hopefully profit in the background while focusing on other things.
It's possible to have either a managed or a self-managed passive investment strategy. If you go for the former, you can appoint a specified third party to make the decisions and then leave it for a while - the so-called "set it and forget it" strategy. This is the way that people who purchase passive investment products like tracker funds often do it, although it's also possible to have a dedicated wealth manager of your own who can make decisions like this for you.
However, the self-managed approach sees the investor set up a series of passive investments and then leaves them to work away in the background - so there's a higher level of upfront effort, but with the aim of a longer-term passive reward.
The advantage
Passive investment has several advantages. The main one, of course, is that there's less time required. The idea of passive investment is that it can work away in the background. Contrast this with the scene for an active investor: they will need to work on their portfolios every day or every week, perhaps adjusting their ratio of bonds to stocks or responding to market movements. That sort of involvement isn't encouraged for passive investing, freeing people up to do other things with their time.
Passive investment is also set up to encourage long-term thinking. Those who have passive investment strategies in place are often encouraged to "set it and forget it," which can reduce the incidence of knee-jerk reactions and emotional trading decisions. Depending on the asset class, this also offers a timeframe in which the asset can appreciate value and experience capital growth: this is especially useful for investing in stocks.
The disadvantages
But passive investment is not without its disadvantages. There's a reason that many people opt for an active investment strategy rather than a passive one. Active investing allows portfolio ratios to change based on how the market is going and to adapt according to shifting conditions. If an active fund manager believes that there is an opportunity for profit, it's possible (with a dynamic and active strategy) to move to it and take advantage.
Passive investing can also encourage a certain level of forgetfulness or even laziness. There have been some instances of people forgetting that they have an active investment open. In some cases, this can lead to investors being stung by high fees that they had not expected to be charged.
It's also worth remembering that passive investment is not necessarily the same as passive income. Passive investment refers to the level of involvement you have in the actual investment process and doesn't make any promises about income. And the offer of passive investment is no guarantee of broker quality either. You should ensure you still read reviews like this Moneyfarm review on top sites like AskTraders before you act.
Ultimately, passive investment makes a lot of sense for people looking to improve their portfolio's position without spending lots of time managing their assets. Advantages of passive investment include the lower time burden, although it does come with downsides - like a risk of missing out on opportunities to profit. In the end, it's down to the individual passive investor to assess the different strategy options on offer and come up with a passive investment method that suits them.
