Investing is how most of us will build wealth, not through our jobs, an inheritance, or winning the lottery. But not everyone has the time or the inclination to put together an investment strategy and then manage their portfolio. And even if we did, how successful would we be? We’re not an investing professional; we’re primarily laypeople or at best, enthusiastic money nerds. We have two choices; use a professional portfolio manager or passive investing.
Active managers are investment professionals; using one will surely increase your market returns compared to making every investment decision yourself or using a passive investment strategy, right?
Not according to a recent analysis by Morningstar:
Only 23% of all active funds topped the average of their passive rivals over the 10-year period ended June 2019.
We don’t have a problem with paying for results, but active management costs money, sometimes lots of money:
The average expense ratio for actively managed
And as you saw above, those higher expense ratios don’t often come with results. Those percentages may look small on paper, but over time, they can take a big chunk of your money.
The choice seems clear, passive
What Is Passive
The best example of a form of passive
When an index sheds or gains one of the
They sell the stock that’s leaving the index and buy the one that’s coming on board.
When you invest in an index fund, you own a tiny amount of numerous different
And yes, you lose money when those
But remember, passive strategies are long-term, and over a significant period, the ups and downs come out in your favor.
Passive vs. Active
The end game for an active
Doing this requires a lot of information, much more than a portfolio manager could do on their own, so they work with analysts who deep dive into
These people think they can determine the exact right time to buy and sell.
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Types of Passive Investments
If you’ve been an LMM listener or reader for a while now, you’re already familiar with various forms of passive investments since passive funds are our preferred method of
But there are other passive investments too.
If there is one area of life for which we welcome our robot overlords, it’s
ETFs are Exchange-Traded Funds, a fund that can be bought and sold on an exchange like a stock. An ETF allows passive investors to buy a whole basket of assets at once rather than putting individual securities into the basket one by one.
The owner of the ETF owns the underlying assets and creates a fund to track the performance of those assets and sells shares in the fund to investors.
Those investors own a portion of the ETF but don’t own the underlying assets.
An example of an ETF is the Vanguard FTSE Emerging Markets ETF, which is a passive
Pros of Passive
Even for those of you who are dedicated DIYers, there are lots of reasons to choose a passive
It Makes Financial Sense
Passive management has lower fees than active management. Cheaper isn’t always better, but in this case, it is. We provided some stats on the outperformance of passive
It Saves Time
Not many people would list
You don’t need to do much research to become a successful passive investor. You don’t need to know stock prices, interest rates, P/E ratios, or any of the other information to make an informed decision when choosing
You could spend an hour or two reading about the various ways to invest passively and which provider to use once you’ve decided how to invest and be done with it.
You can start
Based on your answers, you’ll be recommended a portfolio that best suits your needs.
You don’t even need to really know what in the hell a stock is!
Cons of Passive
While we love and recommend passive
Your Money Is Tied Up
When you use a passive investment strategy, you’re committing to long-term
That means your money isn’t terribly liquid. There aren’t penalties for pulling money out (unless the money is in a retirement fund), part of what keeps passive investments low cost is long-term
Even if you understand that you’re
Just because you’ve left your money invested for many years or even many decades is no guarantee that when you need it, things will be in your favor.
Imagine how many losses you would have realized if you had to pull money out of your investments during the COVID-19 crisis.
While a passive investment strategy can be diverse, it might not be diverse enough.
To truly diversify your investment portfolio, you need to seek out other classes of assets collectively named alternative investments.
You can handle everything yourself or turn all aspects over to a management company that allows you to write and receive a check each month.
If you’re uninterested in becoming a landlord, you can still add some real estate to your portfolio easily and affordably with a REIT (Real Estate Investment Trust).
Landlords get rich in their sleep.Tweet This
You can potentially make great returns by delving into peer-to-peer lending. How do banks make money? By making loans and charging interest on those loans.
Peer-to-peer lending makes you the bank, and you make money the same way.
These are just a few of the alternative investment options that sticking to the typical types of passive investment options mean you’ll be missing out on.
Don’t Pass On Passive
If you’re brand new to