Investing can often seem complicated, confusing and time-consuming. But if you thought that investing means having to read financial statements, checking the stock market every hour and moving money around, then think again. There’s a far easier way to invest, and it’s available to everyone. We’re talking about passive investing — a great way to grow your wealth in the long term.
What is passive investing?
It’s a type of investment strategy where you aim to optimise returns by buying and selling as little as possible. You don’t have to make ‘smart’ decisions on a regular basis to try and beat the market, and neither does a fund manager. Instead, you let your money follow the ups and downs of the market, which ultimately (hopefully!) leads to growth in the long run.
This is called index tracking and it’s the most common method of passive investing.
Instead of researching individual companies and buying their shares, index tracking involves choosing a fund (often a unit trust or exchange traded fund) that tracks a certain benchmark, like the top 40 shares on the JSE (Satrix 40), for example, or 500 large companies in the US (S&P 500). Buying into this fund allows you to expose your money to a wide range of different companies and assets, all at once.
Exchange traded funds, or ETFs, are a great way to invest passively. Click here to learn more about them.
Diversification made easy
If you’ve ever researched how to structure a good investment portfolio, you would have read that diversification is key. Passive investing — and index tracking in particular — makes this super easy since you’re automatically exposed to a wide range of companies and asset classes. You’re not only betting on a handful to grow your money.
In the long term, most passive funds tend to outperform active funds. This is why many investors believe that time in the market is better than timing the market. It all comes down to the magic of compounding. Say you start with R1,000, which grows to R1,200 after a year. The next year you’ll earn returns on your initial investment plus the growth (i.e. returns on the full R1,200), taking your total to R2,000. And so on. It’s like a snowball growing in size exponentially as it rolls down a hill.
It’s cheaper, too
Passive investing is cheaper because you don’t have to pay a fund manager to try and beat the market. You’re not selling shares for profit as often as traders do, and you’re therefore not paying as much capital gains tax (CGT). Fewer transactions also mean fewer transaction costs.
Are there any negatives?
Well, if you’re someone who likes to control everything, you might not like passive investing since you can’t hand-pick your investments. Also, there’s not much chance of your investment outperforming the market since you’re riding the wave instead of trying to shoot out ahead of it.
If you like to watch the market and move your money around in search of the best growth opportunities, then passive investing might not be for you. But it’s a great option if you’d prefer to lie back, relax, and let your money do its thing.
Remember, slow and steady wins the race. Speak to your financial advisor, buy all the books, read the articles and choose a fund that will keep your money growing steadily over the years.