3 of The Best Passive Investing Strategies

Passive investing is a long term buy and hold strategy that focuses on trying to follow and capture the returns of the stock market. The idea here is to follow the stock market, take what it gives you and not try to beat it.

Although many investors have tried to beat the standard returns of the stock market, almost all have failed. Ever heard the saying, "if you can't beat em, join em." With this in mind, passive investing focuses on capturing the long term positive return of the market.

Even though the stock market loses value through volatility, and is subject to crash, it has historically recovered from these crashes and provided a 10% return over long streches of time. Sometimes the market returns more or less than that benchmark.

Passive investors tend to contruct their portofolios using diversified index funds and ETFs that aim to track the performance of the stock market. Funds simply pool the resources of many investors to buy a range of stocks, bonds and other assets. Passive investors believe it will be easier to buy and hold these indexes over the long haul as opposed to trying to profit from short term trading as active investors do.

We should also note that passive investing should not be confused with passive investments. A passive investment focuses on earning passive income by making an upfront investment once, and then getting streams of income from that investment.
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Passive investing on the other hand can be better thought of as an an investing strategy and investing mindset. Passive investing is more of a belief about how you should invest, whereas passive investments are more of the "what" you should invest in.

1) Stable returns over time

Passive investing tends to provide stable returns over time since you are simply trying to follow the market. In other words, when the stock market goes up, so do your investments. Now this is not to say that passive investing does not carry any risk.

The stock market goes up, down, and sideways. Since passive investing aims to follow the stock market, your investments will go up, down and sideways. However, as we previously mentioned, the stock market does tend to go up given enough time. When you aim to be a passive investor over decades, you will do very well.

2) Can be low cost

A second advantage of passive investing is that it is affordable. The funds that make up most passive investors portfolios are not actively being managed by anyone, and instead simply track the performance of the stock market.

This means that the fees are significantly lower than actively managed funds as there is less upkeep required and no portoflio manager that needs to be paid. Having lower fees means more of your dollars stay invested which can help accelarate the growth of your investments thanks to compound interest.

3) Low stress

Passive investing is much more of a set it and forget it strategy which is why it has gained so much popularity. When you invest in indexes that track the performance of the market, you have significantly less stress knowing that your investments will perform well over the long haul.

1) Potentially missing out on higher returns

The first disadvantage of passive investing is that you are potentially missing out on higher returns. Hypothetically, if you were to choose a few individual stocks at the right time and they skyrocketed in value, your return would be higher than if you were to adopt a passive investing strategy. However, this is almost impossible to do, even if you are a professional.

2) Less control over investments

The second disadvantage of passive investing is that you have less control over your investments. Remember, passive investors buy funds that track the performance of the stock market. As the investor, you do not get to choose the individual assets that are held within the fund.

What is an index fund?

An index fund is a pool of stocks and bonds that tracks the performance of a market benchmark such as the S&P 500. When you invest in an index fund, your cash is used to invest in all of the assets held within the fund simeltaneously. For example, the S&P 500 is one of the most popular indexes that tracks the performance of the 500 largest companies within the US.

What are the advantages of index funds?

1) Strong returns: Over long streches of time index funds tend to perform well and provide investors with stable returns. Since index funds are made up of stocks and bonds they are subject to fluctuate or crash, but over time they almost always recover. For example, the S&P 500 has provided an average return of about 10%.

2) Instant diversification: When you buy an index fund, you are often buying hundreds of companies all at once. This can provide instant diversification which can help lower your exposure to market volatility and risk. In other words, if some of the companies in the index are not performing well, other companies that are performing well in the index can make up for it.

3) Low risk: Since index funds are diversified, they are significantly less risky than owning just a few individual stocks. This does not mean that there is zero risk, but index funds tend to fluctuate less than individual assets. Due to this, it will be easier to hold onto an index fund during downturns in the market and lower your stress as you invest.

What are some of the best index funds?

There are many index funds available so to keep things simple, we are going to name just two. The first is the Schwab S&P 500 Index Fund. As the name implies, this fund precisely tracks the performance of the S&P 500. This fund has a low expense ratio of 0.02% which means you would pay a $0.20 fee for every $1,000 you invest.

The second fund is the Fidelity ZERO Large Cap Index Fund. This fund tracks an index of more than 500 US large cap stocks and performs like an S&P 500 Index Fund, although it is technically not an S&P 500 fund. The good news is that there is not an expense ratio charged (hence the ZERO in the name), which means you won't pay any fees.

Where can you buy these index funds?

These funds can be purchased directly through the fund company or through most online brokers.

What is an ETF?

An ETF, or exchange traded fund, is a basket of investments that typically track a specific index. The primary difference between an index fund and an ETF is how they trade. ETFs can be traded throughout the day like stocks, where as index funds can only be bought and sold for the price set at the end of the trading day.

What are the advantages of ETFs?

Since ETFs are very similar to index funds, they share some advantages. Similar to index funds, ETFs also provide stable returns, instant diversification, and low risk. Beyond that, ETFs often have lower minimum investment requirements and can be bought and sold throughout they day. However, if you are a long term investor that won't make to much of a difference.

What are some of the best ETFs?

Similar to index funds, there are a plethora of ETFs available, but to keep things simple, we are going to suggest two. The first would be the Vanguard S&P 500 ETF (VOO). As the name implies, this ETF tracks the S&P 500 and has a low expense ratio of 0.03%. That means you would pay a $0.30 fee on every $1,000 invested.

The second ETF is the SPDR S&P 500 ETF Trust (SPY). This ETF is among the most popular and is sponsored by State Street Global Advisors. This fund also tracks the S&P 500 and has an expense ratio of 0.095%. This means you would pay a $0.95 fee on every $1,000 invested.

Where can you buy these index funds?

These funds can be purchased directly through the fund company or through most online brokers.  

What is a robo advisor?

A robo advisor is a digital financial advisor that uses asset allocation algorithms to build and manage an investment portfolio for you. How does a robo advisor do this you might ask? When you sign up for a robo advisor, you will be asked a series of questions related to your investing goals.

Based upon your answers to these goals, the robo advisors will build a portfolio that is tailored to your goals and your risk tolerance. Robo advisors typically build portofolios using a variety of low cost ETFs and index funds.

What are the advantages of robo advisors?

The biggest advantage of using a robo advisor is that it eliminates the need to choose your own index funds and ETFs as it does that for you. Using a robo advisor is the most hands off approach to passive investing. Additionally, a robo advisor can also help rebalance your portfolio over time.

What does this mean? It simply means the robo advisor can move your money between different ETFs and index funds as needed so you don't have to.

What are some of the best robo advisors?

Some of the best robo advisors available are Wealthfront, Sofi Automated Investing, Betterment, and M1 Finance. Each of these has its own advantages and disadvantages. You can compare them by checking out our post on the top robo advisors.

Step 1: Open an investing account

The first step towards implementing a passive investing strategy is to open an investing account. An investing account will hold your index funds or ETFs. There are a wide variety of account types available, but we recommend starting with one of two options.

The first is a standard brokerage account. A brokerage account simply allows you to buy and sell investments and does not offer any specific benefits. The good news is that almost everyone can open a brokerage account and the sign up process is quite easy.

Your second option would be to open an IRA. An IRA, or individual retirement account, is specifically designed to help you save for retirement. The two most popular IRAs are the Roth IRA and the Traditional IRA. Both of these accounts offer tax benefits. However, due to this, there are also restrictions to these accounts. You can learn more about these accounts here.

The good news is that both of these account types are quite easy to open. You simply go to your chosen broker's website and click on the option to open an account. You can select the account type you want and fill out the paperwork online. Expect to have to provide your contact information, address, income, social security number, and government ID.

Step 2: Fund your account and invest in your chosen funds

After your account is open, you need to deposit money into the account so you can purchase index funds and ETFs. You can do this by connecting your banking information to your investment account. After that, simply transfer your funds over. Once you have money in your investment account, you can buy index funds and ETFs.

You can buy the index funds and ETFs listed above, or use the research tools that brokers offer to find the index funds and ETFs that are right for you. If you don't want to be in charge of choosing your own index funds and ETFs, you can opt to use a robo advisor since it will take care of that for you.

If you opt to use a robo advisor, go back to Step 1 and follow the same steps to open an account. During the sign up process, the robo advisor will ask you a series of questions and use that information to build your investment portfolio using low cost ETFs and index funds.

Step 3: Invest consistently by automating your investing

The final step is to invest consistently. Remember that passive investing is a long term game. The more consistent you are, the more your dollars can compound and build you wealth. Almost all brokers and robo advisors will allow you to set up automatic monthly contributions so that you don't have to remember to invest. After you have completed Steps 1 and 2, choose a dollar amount that you are comfortable investing each month and set up automatic contributions.

The bottom line is that passive investing is a long term buy and hold strategy that aims to capture the standard returns of the stock market. Passive investing has grown increasingly popular among both new and experienced investors due to the easiness of the set it and forget it style.

You can participate in the passive investing strategy by buying and holding index funds, ETFs, or a combination of the two that track the performance of a market benchmark. If you want to make your life even easier, you can use a robo advisor to choose your index funds and ETFs for you.