How to Gradually Build Wealth Using Passive Investing

Passive investing or passive management investment strategy, otherwise known as a “buy and hold,” aims to give investors a solid return by holding assets over the long term. As the market rises over time, investors take advantage of those gains. Rather than trying to beat the market by frequent trades in and out of stocks, a passive investor’s goal is to benefit from steady market growth and gradually build wealth with a diversified portfolio. A passive investment is therefore a good blueprint for saving for retirement.

An active investment approach is quite the opposite of passive investing. An active investor attempts to time the market and buy certain stocks that would provide above-market returns. In an active management strategy, investors frequently buy and sell stocks.

Because stocks and other investments are held for many years, passive investors incur fewer fees. Conversely, investors actively managing a portfolio will be hit with frequent transaction charges.

Index funds are a popular investment vehicle in a passive investment plan. An index fund attempts to match the performance of an market index, such as the S&P 500. Because index funds conduct fewer trades, fees are lower. On the other hand, index funds are not designed to outperform the market.

A mutual fund pools money from shareholders to buy a collection of stocks, bonds, and other investments. With a mutual fund, you are getting a diversified portfolio managed by a professional money manager.

Exchange-traded funds track major indices, such as the S&P 500, MSCI Indexes, and the Dow Jones Industrial Average. Another difference between ETFs and other funds is that they can be traded like a stock.

Instead of riding the hottest stock at any one time, a passive investment strategy rides out the market storms through diversification. Your investments are spread over a number of vehicles that are professionally managed with diversification in mind, so you are not locked into any one asset that may crash and leave you with considerably more loss than you wanted to risk.

Let’s face it: Trading stocks is hard work, and you could end up with significant losses if you pick the wrong ones. In passive management, a professional money manager is doing the work for you. Yet you always know what is in the fund. Another advantage is that your fees will be lower than if you tried to actively manage your portfolio. Also, by holding investments over the long term and with fewer trades, you are unlikely to have a massive capital gains tax at the end of the year.

With a passive investment strategy, you are invested in predetermined investment vehicles. While your rate of return may be slightly higher than the market with this hands-off approach, you probably will not get spectacular gains. Riskier investing strategies, including active management can have higher returns (but also far worse returns).

If you like to be more involved in managing your portfolio and pick individual holdings to aim for higher returns, a passive management strategy may not be the best option for you. Passive investment is for those who want to smooth out the market upheavals with diversification, reaping steady, but not outsized, gains.

Before embarking on either approach, ask yourself how much risk you are willing to take. If you don’t mind shouldering more risk, try your hand at active management. Risk-averse investors would be better served by passive management.

Which strategy you choose depends on where you are in life and what your objectives are for your money. Want to buy a house in the next three to five years? An active management plan will potentially help with faster gains and get you the funds needed to make that purchase. If you envision a longer-term savings goal such as building a retirement nest egg or a college fund for your toddler, your wiser choice may be a passive investment strategy.