Predicting market movement, searching for companies that can outperform others, and making strategic investments is not something that all investors would want to do. So, many investors choose to take a passive investment approach to match the market rather than trying to beat it.
Passive investing is an investment strategy that involves creating a portfolio that tracks an underlying index such as NSE Nifty50 and S&P BSE Sensex and then holding them for the long term. Exchange Traded Funds (ETFs) and Index Funds are examples of investment products that adopt this strategy.
The buy-and-hold strategy is the essence of passive investing – purchasing securities with the purpose of holding them for the long term. This investing approach can be appealing to investors who don’t want to actively manage their portfolios or don’t want to time the market for short-term price fluctuations. Moreover, passive funds simply track an index, so they don’t incur the same research and expertise costs as actively managed funds.
What are passive mutual funds?
Passive mutual funds are investment funds that seek to track a particular index’s performance. Unlike actively managed funds, where professional fund managers or teams regularly make buy, hold, and sell decisions, passive funds seek to mirror the performance of the underlying index.
Is passive investing profitable for investors?
Each investor has different goals, tenure, risk appetite, and financial obligations. However, the following are some crucial features of passive investing that can give investors an idea of whether this strategy can be profitable for them.
- Low-maintenance investment strategy
One of the major advantages of passive investing is that it requires very little direct management from an investor. Index funds and ETFs don’t need to be actively monitored or traded as individual stocks do. Here, the fund manager is just involved in building and rebalancing the underlying securities to align with the fund’s asset allocation strategy. This makes them ideal for those who find it difficult to manage their investments on a daily basis.
Passive investing is less expensive than active management due to its low-maintenance nature and the fact that you don’t need a financial advisor or broker to manage your investments. Index funds and ETFs generally have much lower expense ratios, allowing investors to keep more of their money invested rather than spending it on costly fees.
Also, the expense ratio of a passive fund is capped at 1% by SEBI (Securities and Exchange Board of India), so a fund house cannot levy more than a 1% expense ratio on passive funds. This makes them particularly attractive for those who are just starting out with their investment portfolio or those who want to minimise their expenses while still participating in the market.
Passive funds also offer liquidity, which is a critical factor for many investors. Some passive funds, like ETFs, can be traded live throughout the trading hours based on their current market price. This gives investors the flexibility to enter and exit the fund as needed and can be crucial in volatile markets or when an investor needs to quickly take advantage of market conditions.
- Power of compounding
Passive investments are powered by compounding. That means that you stay invested in the same investment for a long period, and your investment earns interest on the interest that it has already earned. This has an exponential effect, which can lead to significant growth in your investment over time.
To understand this better, let’s take an example. Let’s say you invest Rs.1 lakh in a passive fund offering you 10% p.a. for 5 years. In the first year, your investment will grow to Rs.1.1 lakh (principal + interest). Now in the second year, you will not only earn 10% on your original investment of Rs.1 lakh but also on the interest that was generated in the first year, which is Rs.10,000. So effectively, in the second year, your investment will grow to Rs. 1.21 lakhs (principal of Rs.1 lakh + interest of Rs 21,000).
This is the power of compounding at work, which is why most financial experts always emphasise on investing early because time is money when it comes to compounding! Low maintenance costs, reduced risk levels due to diversification, and less volatility caused by long-term investment horizons are some of the key reasons why passive investing might be suitable for many different investors looking for consistent returns over time without having much involvement in day-to-day decisions.
Also, one can easily invest in the best passive mutual funds in India online with minimal documentation and construct a portfolio that aligns with their specific goals and risk tolerance.