Passive Investing – What Exactly is It?
With the cost of living rising in the UK, it’s only reasonable that more and more people are looking into ways to make extra money as a sideline. Investing has never been easier to get into – thanks to the rise of apps such as Nutmeg and MoneyFarm, anyone in the UK can set up an online portfolio with a small cash deposit.
In fact, there’s a significant rise in passive investing, too. But what does ‘passive’ actually mean in this context? Are you actively choosing stocks and shares to buy – or is it completely autonomous? Let’s take a closer look to try and cut through some of the myths and misconceptions.
Passive Investing: A Quick Definition
Passive investing is a long-term approach to making money on the markets. While active investors hunt down profitable stocks and try to make money in the short term, the passive approach revolves around careful management for months (and even years) to come.
Passive investors typically don’t take on much buying and selling – at least, not until things look more secure further down the line! What’s more, when passive investing, you’re likely to put money behind index funds and ETFs (exchange-traded funds), which are bundled investments – largely based around common market fluctuations.
For investors in the passive game, this provides a lot of clarity. The assets included in a passive ETF are always made clear at the point of investment. What’s more, the process tends to be much cheaper over the long run.
That’s largely thanks to the fact you do not have to pay for the processing of every single piece of stock you buy and sell. While active investing may deliver quick wins if you are shrewd enough, there’s the danger that you’ll pay more in the long term.
Why Might Passive Investing Be a Good Idea?
As mentioned, enhanced clarity and reduced fees potential are big positives for getting into a passive game. However, there’s also reduced tax to keep in mind, too!
When actively investing, you stand to pay more in capital gains tax when filing your return at the end of each January. This, again, is largely thanks to the fact that you are trading multiple different stocks throughout the year. With a passive investment strategy, you’re only ever paying fees and rates on a lump sum – and it’s one you’re holding onto.
Passive investing tends to be a great idea for those people who are completely new to trading. That’s because there’s no need to keep a constant check on the markets, and because fluctuations are unlikely to be as detrimental – or even as volatile.
Many people who travel the passive route observe buy and hold. This means you are essentially purchasing an ETF or index fund with the aim to grow your money over a long period. If you’re not after quick wins and are more interested in money growth potential over time, this is likely to be a more appealing opportunity than diving straight into the markets.
The great news is that many apps and platforms offering ‘robo advisors’ – where artificial intelligence invests for you – operate on a passive basis. That means you can effectively get started as hands-free as you desire. Of course, there are still benefits to investing actively, but it’s a good idea to consider both strategies before you put any money down.
Why Might Passive Investing Be a Bad Idea?
Passive investing won’t get you much in the way of huge returns very quickly. In fact, some critics of the passive model advise that you may even get lower returns through passive investments than through active portfolio management. That, of course, is as a result of taking advantage of market dips and peaks as soon as they arise.
There’s also the matter of ETFs and index funds typically mimicking market trends. This means that if there are big valleys or peaks across the year, your portfolio could miss out. Conversely, this does at least mean you have a safe cushioning in case of massive volatility when you least expect it.
Many people prefer active investing because it provides more variety and variance. You’re never restricted to market predictions. One of the major criticisms of the passive model is that it’s simply not freeing enough for those investors really wanting to make big strides.
That said, none of these disadvantages involve losing money you already have, or paying more money in fees or tax. The main drawbacks to passive investments revolve around missed potential, whereas the drawbacks to active investing see you losing control, or money, in the short term.
So – Will I Make Less Money From Passive Investing?
No, not necessarily! As mentioned, those investors banking on the active dips and peaks of the markets are at risk of losing cash with every stock. It’s a game that requires active participation – hence the name – if you really want to outrun the risks involved.
Passive investment is safe, but slow. That said, while it may miss out on some profit potential, if the markets have a particularly bad spell, the safety of an index fund is likely to come as some relief.
Crucially, many investors see the benefits to both active and passive investing. It’s entirely possible to do both – to have an active portfolio where you keep an eye on the markets as much as possible, and an index fund in another, which you can leave to build a little money over the months.
Passive investing is a great idea for trading newbies as it comes with far lower risk potential compared to active investing. It’s also a great place to start and ‘learn the ropes’ if you’re keen to get into the markets for the long haul.
As always, be sure to contact a financial advisor if you’re unsure about making money from investing. If you do decide to invest passively with an app or online platform – check they are FSCS protected (for compensatory needs) – and read individual reviews. You never know where you could grow your money to – but take care, all the same!
As we’ve touched on, passive investing isn’t for everyone, but if done correctly it can yield some decent Wonga over time. If you’ve found a passive investment worth trying but need a loan fast to fund it, you can easily compare your loan options here at LoanBird.