Top 5 Myths About Passive Investing

Passive investing is a long-term investment approach with the objective of building wealth gradually over time. By minimizing buying and selling, passive investing increases long-term returns through cost savings. Passive investing continues to gain traction as more and more investors abandon actively managed funds in favor of passively managed alternatives. However, if you want to get involved, take a look at these myths first so you don't start off misinformed.

 Passive investing is only for inexperienced investors.

Not necessarily. It’s true that passive investments such as index funds or ETFs are very easy for investors to track and comprehend. For individuals who want a simpler investment without having to continually monitor their portfolio, passive investing is ideal. But it’s also appropriate for more experienced investors who are cost-conscious and hesitant to assume financial risks associated with choosing a fund management.

 Passive investing typically yields lower returns.

It’s getting harder for actively managed funds to outperform the benchmarks. While actively managed funds aim to surpass the market returns, passively managed funds aim to mirror market returns. However, this does not imply that passive investments produce inferior returns. And in the long term, passive investments are rarely outperformed.

 The returns from passive investing match those of the index.

Not always. Theoretically, passive investment tools generate returns that are identical to the index. However, there may be circumstances in which a specific passive fund is unable to match index returns due to a variety of factors, such as the need for an index fund to keep cash on hand for redemptions, mutual fund costs, or the inability to purchase a stock at the index price. This disparity is called a tracking error.

 Passive investing limits portfolio diversification.

It’s debatable. Passive funds provide broader market access because they follow an index. Additionally, there are passive funds that monitor foreign indices as well as funds that bring regional diversification to a portfolio. Sectoral ETFs can also provide sectoral exposure at a lesser cost.

 Passive investing is a risk-free alternative.

Overall, passive investing has the same risk as active. Despite the lower costs associated with fund management, equity markets are vulnerable to systematic risks. These could be economic, geographical, political, or interest rate risks. If you’re investing internationally, you also face current rate risks.

Put simply, because of its potential to be relatively inexpensive and straightforward, passive investing is quite a promising approach. But regardless of how you invest, you should always keep in mind and put the fundamentals of investing into practice. These include paying attention to your risk profile, asset allocation, and maintaining diversification.

xx, Danae