PASSIVE INVESTING: IS IT RIGHT FOR YOU?

Many investors are weighing the potential advantages of passive investing over active investing. Understanding what passive investing is can help you make an informed investment decision that aligns with your investment objectives. Fifty years ago, investing meant actively buying and holding stocks, often involving active management by fund managers. But in 1976, then-CEO of The Vanguard Group, John C. Bogle, pioneered the index fund, allowing individual investors to buy shares in a fund that mirrored the S&P 500. This passive investment strategy revolutionized investing by making it more accessible to the everyday investor and laid the foundation for index investing and passive index funds.

Active vs. Passive Investing

In active investing, active investors buy and sell individual stocks – either directly or through an active fund manager – attempting to time and beat the market. You must be willing to put the time and work into researching companies, handpicking stocks, and actively managing each asset in your investment portfolio. Active investment involves continuous monitoring and making frequent investment decisions to adjust your asset allocation.

In passive investing, passive investors invest in a mutual fund or exchange-traded fund (ETF) that includes a range of assets to mirror what the stock market is doing. These passive investment funds, such as index mutual funds and passive index funds, give you the option to invest across industries and interests, helping you to diversify your portfolio. With this passive strategy, you invest fully in a fund for the long term rather than making frequent transactions as you would with active investing. This approach allows for passive management of your portfolio, reducing the need for constant oversight.

Pros and Cons of Passive Investing

If you’re trying to decide if a passive investing strategy is best for you, you may want to consider the following pros and cons in relation to your investment objectives and financial planning:

Potential Benefits

• Lower fees. Since passive management typically involves less frequent buying and selling of individual stocks, passive investing may result in lower fees compared to active funds with active management.
• Less maintenance. Passive investors don't need to spend time tracking individual stocks or attempting to predict the market. You're not performing active portfolio management or making frequent investment decisions.
• Returns over the long term. Data over the past decade shows that passive funds, such as passive index funds, may outperform actively managed funds over time. S&P Indices versus Active data revealed more than 90% of domestic funds underperformed the S&P 500 over a ten-year period (June 2014 – June 2024). This suggests that a passive investing strategy may be better than an active strategy over the long term.
• Tax efficiency. By adopting a passive investment strategy and holding assets over the long term, rather than making frequent investment decisions to buy and sell stocks, you could pay less in capital gains taxes. The trading volume in a passive investment fund, such as a passive index fund or index mutual fund, is generally lower compared to active vehicles, which may trigger fewer fees and less tax consequences.

Potential Drawbacks

• Limited choice. When you invest in an index fund or ETF, you're investing in the entire passive portfolio. You don't have the option of handpicking individual stocks or deselecting specific assets in the fund. Passive investors may find this lack of flexibility limiting compared to active investors who can tailor their investment portfolio to their individual preferences.

All that said, historically speaking – though past performance is not a guarantee of future returns –staying invested over the long term may provide a more favorable return than trying to time the market, which can align with your investment objectives and financial planning goals.

Passive Investing Strategies for the Long Haul

According to Morningstar, the performance data suggests that investors, including professional fund managers, struggle to perform better than their average index peers. So, an active strategy often may fail to outperform a passive strategy over the long term. You could be better off maintaining a long-term focus with a diversified portfolio.

There are many major asset classes and market sectors, and in any given year, some will outperform others, but there is no consistent pattern. Past performance doesn’t guarantee future results. So, it’s best to consider owning a diversified portfolio designed for your risk tolerance and goals, with proper asset allocation across different investment funds. By adopting a passive investing strategy and staying fully invested in the major asset classes and market sectors, you can potentially mitigate risks and work toward your investment objectives.

The Bottom Line on Passive Investing

With potentially lower fees, less maintenance and tax efficiency, there’s no wonder why passive investing has become so popular among investors focused on long-term growth. That’s not to say that actively managed funds don’t also sometimes play a role. At Edelman Financial Engines, we use a set of quantitative and qualitative screens to assess whether it may make sense to combine an index and an actively managed fund in the same asset class. So, we’re not taking a dogmatic view, but rather using a strategic process to help find the right investment mix. If you want to learn more about how passive investing can assist with your financial planning and help you meet your financial goals, connect with a planner today to discuss your investment options and find the right fit for your investment portfolio.