What are passive funds?
An example is the S&P 500 – a stock market index which measures the performance of the top 500 companies in the United States’ stock exchange. The idea is that if the market is up by 2.5%, your investment will also increase by 2.5% as it simply mirrors the index. Unlike active managed funds where experts handpick stocks for you to “beat the market”, passive funds do not require active management and therefore incur much lower administration costs. This is because the focus is more geared towards “reflecting the market”, so to speak.
KEY TAKEAWAYS
- A passively managed fund is an Exchange-Traded Fund (ETF) which tracks a specific industry or a certain market index
- Examples include the S&P 500, FTSE 100 and The Dow Jones
- The focus is to "reflect the market" rather than "beat the market"
- Does not require expert management, and therefore incurs smaller fees than an active fund
- Since you’re tracking a specific index, you will always know exactly how well your fund is performing
Advantages of passive investing
- Low-cost fees: By following an index and not requiring an active manager to oversee investments, passive funds incur lower fees.
- Transparency: Since you’re tracking a specific index, you will always know exactly how well your fund is performing.
- Diversification: Investing in a passive fund allows you to diversify your portfolio through a single fund, covering a variety of sectors and industries.
- Less-time consuming: You don’t need to constantly strategise and make decisions about your holdings. This helps to remove a lot of the guesswork when it comes to your portfolio.
- Buy and hold: Long-term investors are able to execute a buy-and-hold strategy compared to active funds.
Disadvantages of passive investing
- Limited scope: Following a benchmark means there is no scope to modify holdings, even if the market is performing badly. So if the market performs poorly, so will your investments.
- Smaller potential returns: Unlike active funds where managers seek to outperform the market, passive funds will rarely achieve that meaning that returns are on a lower scale. Returns will only be higher if the overall market performance is higher – in other words, when there is an economic boom.
What is an example of a passive investment?
Passive investments are typically associated with index funds. These include the Vanguard 500 Index Fund, SPDRF S&P 500 ETF and Vanguard Total Stock Market Index Fund.
If you want to learn more about the difference between passive and active funds you can learn all about it by clicking here