Passive Investing Principles You Need to Know
When you get right down to the nitty-gritty, the main idea behind investing is creating a future lifestyle that you can truly enjoy.
Ideally, it won’t be too far into the future — and you won’t have to complicate your present lifestyle too much in the meantime.
That’s why the idea of passive investments is so appealing to many. You don’t have to spend huge blocks of time researching individual stocks… reading the Wall Street Journal to stay up-to-date on market developments… or stressing out about whether or not to sell shares on the latest downturn.
If you prefer episodes of Insecure over the talking heads on CNBC, taking a more passive approach to investing may be the right move for you.
Passive investing generally refers to a strategy for long-term investment with minimal amount of trading activity. The benefits of using this strategy include:
- Requires smaller on-going time commitment
- In many cases, it’s cheaper. You’ll likely pay fewer transaction fees and less in taxes than more active strategies.
- It often generates better results when compared to more active strategies over medium to long timeframes.
Investors who lean in the direction of more active investing will point out a few downsides to taking the passive route:
- Less flexibility. With longer holding periods and less rebalancing (buying and selling to get exposure to different sectors or asset classes), you’re more locked into the investments once you make them.
For investors who like to jump on hot trends, this is a downside.
- Potential underperformance in the shorter term. Passive investing tends to go for smaller, more conservative returns that compound over time. More active investors can target more aggressive growth, which can lead to bigger gains — and also more frequent, bigger losses, too.
Depending on your goals (and your risk tolerance), you may find that the pros of passive investing outweigh the potential cons.
5 Principles to Apply ASAP
If you’re one of the growing number of people interested in passive investing, here are some key principles that can help you get started:
1) Saving is NOT passive investing
Saving is not investing at all. Saving is saving. Saving accumulates cash to pay for short-term expenses, whereas investing is designed to grow money for longer-term wealth building or retirement.
In a savings account, your money really isn’t working for you. With the tiny interest rates the majority of banks offer, your money is actually shrinking when you adjust for inflation!
2) You can set it and (practically) forget it
Your work retirement plan is probably the easiest way to get invest passively. You can set up automatic payroll deduction so a percentage of your check goes into a 401(k), 403(b), IRA, etc. In most cases, these retirement accounts are invested in stocks, bonds and/or mutual funds.
So you’re investing in the market every month without lifting a finger.
3) Paying your bills may get you in the game
Some utility companies allow you to buy shares of their company by paying a little extra on your bill. You can buy pieces of the company while doing an activity you already engage in every month. Utilities are generally considered to be conservative, low-volatility stocks. They tend to be great for long-term core holdings in your portfolio.
4) Let it snow(ball)
It’s possible to invest in such a way that your stocks actually buy you more stocks without any activity on your part. Many companies reward their shareholders once a quarter by paying dividends. Dividends are basically a portion of the company’s earnings; as a shareholder, you get to participate in those earnings.
Dividend reinvestment plans (DRIP) take your quarterly dividend payments and automatically reinvest them into buying more shares of the company stocks. That means your stocks are buying more stocks.
Your dividend payments can put cash in your pocket. DRIP plans passively put your money back into stocks that you like — and keep your money working for you.
5) Consider being a little less passive
If you want to be slightly more involved in your investments, consider applying a buy-and-hold strategy to your favorite “blue chip” stocks.
A blue chip is a nationally recognized, established, and financially strong company. These companies often sell name-brand products or services. Their stocks are solid performers that tend to do well in all kinds of economic conditions. As a result, they’re considered by many to be attractive candidates for holding long-term.
Even though passive investing can be simple, there are still countless options available. You may want to speak with a financial professional who can help you explore the possibilities and determine what seems to be the best fit for your goals.
Freeman Capital Advisors is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.