Learn why passive investing beats active investing (2024)

Passive investing refers to the strategy of buying funds that mirror the holdings of market benchmark indices such as the , and holding the funds for a long time.

The objective is to match the performance of the indices, rather than to beat them. Such funds can be bought through your brokerage account, mutual fund companies, or robo-advisors.

In contrast to passive investing, active investing involves the short-term trading of securities based on extensive research and analysis by a portfolio manager to try to beat the market.

What is an index fund?

An index fund is designed to be a passive investment that mimics the performance and composition of a financial market index. It can come in the form of a mutual fund — known also as a unit trust — or an exchange-traded fund (ETF).

A vast array of indexed mutual funds and ETFs track the broad market as well as narrower sectors such as small-cap stocks or stocks in specific industries.

The first index fund was created by John ("Jack") Bogle, the founder of asset management firm Vanguard. He revolutionised investing with his philosophy and belief that to succeed in investing, investors should buy exposure to the entire market, rather than stock pick. That's how the trillion-dollar passive investing industry was born.

The Vanguard 500 Index Fund has been tracking the S&P 500 consistently. As of March 2022, Vanguard’s Admiral Shares posted an average annual return of 7.87%, close to the S&P 500’s 7.89%.

Unit trusts and ETFs are very similar in the way they offer diversification of stocks and can both suit the long-term investor.

The main difference between them lies in how investors buy and sell units or shares. ETFs can often be traded like a stock throughout the day on a stock exchange. On the other hand, unit trusts trade at the net asset value of the fund, which is based on the day’s market closing price, and can appeal more to long-term investors who do not need intraday liquidity.

In some instances, unit trusts may be more expensive than ETFs — but this is not always the case. There are in fact lower-cost share classes for unit trusts, with management fees that are in line with or below ETFs for similar or better-implemented exposure. It is important to understand the fees involved for ETFs and unit trusts. Endowus has also launched the lowest cost passive index fund series in Singapore.

Another big misconception is that all ETFs are passively tracking the markets while all mutual funds are actively managed. The truth is, there are numerous ETFs that are not indexed or traded actively, and many also track different sub-sectors of a single country’s market. At the same time, there are also unit trusts that are passive indexed funds.

Why passive investing should form a core part of your portfolio

You might ask: “Why should I invest at all?” After all, saving your money essentially guarantees that you will not make any losses, whereas investing comes with risks.

Indeed, savings can provide a safety net when it comes to unexpected expenses, and they also lay the foundation for building your wealth. But by itself, saving is not sufficient to manage inflationary pressures — your money, sitting in a bank account drawing low interest rates, is unlikely to grow at the same pace as inflation, which hurts the purchasing power of that cash.

That is where investing comes in. Investing can grow your wealth by putting your money to work today with the expectation that it will subsequently provide a rate of return that makes the delayed gratification worthwhile.

Passive investing in particular also lowers your risk as it spreads your investments across a mix of asset classes, industries, and geographies, instead of an individual stock.

Lately, many investors have preferred passive investing to active investing. This comes as active mutual fund managers’ returns have consistently trailed those of passive funds over a recent 10-year period.

Moreover, passive funds tend to charge lower fees than actively managed funds. This difference in fees can have a significant effect on investors’ returns when compounded over longer time frames.

You can apply a passive investment strategy on your core portfolio — such as your retirement fund — to lock in steady returns in the long run, and then also explore market trends and themes with a smaller portfolio allocation to enhance your returns. Learn more about core-satellite strategies here.

Here are some ways people earn additional income from passive investing in Singapore.

To get started with Endowus, click here.

Next on the Endowus Fin.Lit Academy

Read the next article in the curriculum: Building a classic 60/40 investment portfolio

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Investment involves risk. The value of investments and the income from them can go down as well as up, and you may not get the full amount you invested. Past performance is not an indicator nor a guarantee of future performance. Rates of exchange may cause the value of investments to go up or down. Individual stock performance does not represent the return of a fund.

Any forward-looking statements, prediction, projection or forecast on the economy, stock market, bond market or economic trends of the markets contained in this material are subject to market influences and contingent upon matters outside the control of Endow.us Pte. Ltd (“Endowus”) and therefore may not be realised in the future. Further, any opinion or estimate is made on a general basis and subject to change without notice. In presenting the information above, none of Endowus Pte. Ltd., its affiliates, directors, employees, representatives or agents have given any consideration to, nor have made any investigation of the objective, financial situation or particular need of any user, reader, any specific person or group of persons. Therefore, no representation is made as to the completeness and adequacy of the information to make an informed decision. You should carefully consider (i) whether any investment views and products/ services are appropriate in view of your investment experience, objectives, financial resources and relevant circumstances. You may also wish to seek financial advice through a financial advisor or the Endowus platform and independent legal, accounting, regulatory or tax advice, as appropriate.

I'm an investment enthusiast with extensive knowledge in passive investing and related financial concepts. My expertise is grounded in a deep understanding of the principles and strategies behind passive investment vehicles, such as index funds and exchange-traded funds (ETFs). I'll provide insights into the key concepts covered in the article you shared.

Passive investing involves strategically purchasing funds that replicate the holdings of market benchmark indices, like the S&P 500, and holding these funds for an extended period. The primary goal is to match the performance of the chosen indices rather than actively attempting to outperform them. This strategy can be executed through various channels, including brokerage accounts, mutual fund companies, or robo-advisors.

An index fund, a cornerstone of passive investing, is designed to mirror the performance and composition of a financial market index. These funds can take the form of mutual funds or exchange-traded funds (ETFs). John Bogle, the founder of Vanguard, pioneered the first index fund, advocating for investors to gain exposure to the entire market instead of engaging in stock picking.

The Vanguard 500 Index Fund, tracking the S&P 500, exemplifies the success of passive investing, posting returns close to the benchmark. Unit trusts and ETFs, while similar in offering diversification, differ in how investors buy and sell units or shares. ETFs are traded on stock exchanges throughout the day, providing intraday liquidity, whereas unit trusts trade at the net asset value based on the day's market closing price.

It's essential to dispel the misconception that all ETFs are passively tracking markets, and all mutual funds are actively managed. There are actively traded ETFs and passive index funds in both categories. The article emphasizes the importance of understanding the fees associated with ETFs and unit trusts, with options for cost-effective passive index fund series available in the market.

Passive investing is recommended as a core part of a portfolio due to its ability to spread investments across various asset classes, industries, and geographies, reducing risk compared to individual stock investments. The article highlights the preference for passive investing over active investing, citing consistent underperformance of active mutual fund managers and lower fees associated with passive funds.

Investing, including passive strategies, is portrayed as a means to grow wealth by putting money to work with the expectation of favorable returns. It's positioned as a necessary step to counter inflationary pressures, as savings alone may not keep pace with inflation. Finally, the article suggests applying a passive investment strategy to core portfolios, like retirement funds, for stable long-term returns, while exploring market trends with smaller portfolio allocations.

In summary, passive investing, particularly through index funds and ETFs, is presented as a prudent strategy for long-term investors, offering diversification, lower risk, and potential cost savings compared to active alternatives.

Learn why passive investing beats active investing (2024)
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