Passive Investing: Is It Better Than An Active Strategy For Achieving Financial Freedom?

A passive investment strategy is often considered a good approach for those looking for consistent long-term results with minimum hustle.

In short, passive investing follows the concept of “buy and hold,” looking to mirror the market’s average returns in order to build wealth over time.

While a passive investing approach may provide smaller returns in the short term than an active strategy, it carries significantly less risk and offers many benefits for investors who may not have time to focus on the markets.

Index Funds: The Key For Passive Investment

Market indexes are instruments built to track the performance of a certain group of stocks, bonds or other assets.

The S&P 500, for instance, is a market index published by financial firm S&P Global, that tracks the performance of the 500 largest publicly-listed companies in the United States. 

A diversified portfolio is considered a key to minimizing risk in investing. The opposite of diversification would be to put all of your eggs in one basket. If you invest all of your savings into one company and its stock does well, your returns can be fantastic. But if the stock price suddenly drops, you risk losing it all.

When a portfolio is diversified, risk is reduced. Some companies or assets in your portfolio might go up, some might go down, but over the long run, your returns should turn out positive in most cases.

Index funds were created for investors to be able to diversify their investments without having to purchase individual stocks from separate companies.

ETFs, or exchange-traded funds, are index funds that can be bought and sold as stocks, and allow investors to own stocks in an entire sector or industry.

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There are many ETFs that follow the aforementioned S&P 500 index, those include SPDR S&P 500 ETF SPY, iShares Core S&P 500 ETF IVV and Vanguard S&P 500 ETF VOO.

The S&P 500 is considered to be a broad index providing exposure across industries, and it has realized average returns of 10.57% annually since 1957.

That doesn’t mean that investors holding index funds tracking the S&P 500 will be guaranteed a 10% return on their investment every year. In fact, the S&P 500 has actually lost value on a yearly basis in many cases, including in 2022, 2018 and 2015.

But when looking to build wealth over 10, 20 or 30 years, the S&P 500 can be a low-risk alternative with a historically positive performance.

Many other passive indexes exist aside from the S&P 500, each with its own associated ETFs that investors can pick from.

These can follow specific industries, like the NASDAQ 100 Technology Sector Index following the tech sector, with the ETF Invesco QQQ Trust Series 1 QQQ following it.

Other sector-specific ETFs include Invesco Dynamic Energy Exploration & Production ETF PXE which tracks the oil and gas sectors or iShares Russell 2000 ETF IWM which tracks smaller U.S.-based companies.

There are hundreds of passive ETFs to choose from!

Passive vs. Active Investment: Which One’s Right For You?

Active investing can yield bigger returns, but also encompasses more risk.

Active investors can buy and sell single company stocks and other assets in order to make a daily profit from their changes in price. This is a strategy that’s referred to as “day trading” and requires more extensive knowledge of the capital markets, constant attention to price shifts and higher costs from trading fees and tax-related expenses.

There are also ETFs and mutual funds that are actively managed. In these ETFs, instead of following specific indexes, human fund managers will buy and sell shares of companies in the fund in an effort to beat the market’s performance.

Active funds typically have higher operational fees associated with the workload of curating the fund’s asset list, and are liable to risk in the case of poor performance.

Proponents of passive investing believe that timing the market is too complex and doesn’t guarantee better returns in the long run. They also point out that the cost of maintaining an actively-managed portfolio can outweigh the potential capital benefits.

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