While actively managed funds still dominate the investment landscape, over the past few years, more and more investors have been turning to passive investing. Find out what passive investing is, why you should care and how to invest passively.<\/p>
Passive investing is an increasingly popular investment strategy<\/a>, where the investor tries to replicate an index (like the FTSE 100<\/a>) and hold it for a long time. The strategy minimises buying and selling in order to save costs.<\/p> Passive funds have a number of different names including index funds<\/a>, exchange traded funds (ETFs)<\/a> or trackers. They will aim to replicate the performance of an index.<\/p> In the case of mainstream indices such as the FTSE 100 or S&P 500<\/a>, the index simply tracks the share price of the largest shares listed in a specific region.<\/p> In the case of the FTSE 100, this is companies such as HSBC<\/a>, BP<\/a> or AstraZeneca<\/a> \u2013 large global companies that draw their profits from across the globe. For the S&P 500, that will be the large technology names such as Amazon and Apple, alongside Johnson & Johnson and Exxon Mobil. The largest companies will have the largest weighting.<\/p> There are indices that look at criteria other than size \u2013 the Nasdaq<\/a>, for example, focuses in on the leading technology companies, while the S&P 500 Dividend Aristocrats focuses on those companies paying the highest dividends<\/a>. It is possible to find passive funds for these indices too.<\/p> Investors should always know what to expect with a passive fund. If the FTSE 100 rises 10%, so should their investment. Many investors like this simplicity.<\/p> \u201cETFs\u201d or exchange traded funds are a type of index fund. As the name suggests, they trade on an exchange so are bought and sold like normal shares.<\/p> They are usually super-cheap, even by the standards of passive investment, often only charging 0.1% for the most popular indices. Not all investment platforms offer ETFs, so investors need to make sure they\u2019re with a platform that offers share trading.<\/p> Find out more about ETFs in our full guide<\/a>.<\/p> They\u2019re low cost<\/strong> and simple.<\/strong> Let\u2019s look at both.<\/p> One big appeal of a passive fund is the low cost<\/strong>. An active fund will usually charge 65p\u201375p for every \u00a3100 you invest. A passive fund on one of the well-known indices may cost as little as 10\u201315p, with ETFs even cheaper.<\/p> This difference doesn\u2019t sound a lot, but can really add up over time. Get ready, we\u2019re going to do some maths.<\/p> At 5% growth, a \u00a320,000 investment would grow to \u00a369,625 over 25 years (assuming 5% growth). Shaving 0.5% off each year in costs would see this drop to \u00a361,470.<\/p> Active managers will argue that their expertise can help people to greater returns than those available from an index. Importantly, it can also help protect capital in falling markets, when passive managers may be condemned to track the index lower.<\/p> In some cases, this is true, and certain active managers have delivered returns well in excess of the index and\/or protected investor returns in falling markets. However, it is tough to pick the really skilled fund managers and some will go off the boil.<\/p> Another big draw when it comes to index funds is simplicity<\/strong>. They take some crucial elements out of the decision-making process.<\/p> However, you need to be aware that, for the most part, you\u2019re getting a portfolio of the UK\u2019s (or US\u2019s or Europe\u2019s) largest companies. If you\u2019re looking to find the next Apple before anyone else, this isn\u2019t the right option for you.<\/p> You will still have choices to make, such as which country, which sector and which index. It is worth remembering that you can always use passives for your core exposure, bringing in some racier elements round the sides \u2013 smaller companies or emerging markets, for example.<\/p> Passives have become very popular in recent years and it is easy to see why. They offer a cheap and easy way to get diversified market exposure, without the hassle of having to choose which fund manager is having a good moment.<\/p> The simplest way to picture the difference is to think of an active approach as \u201chands-on\u201d and a passive strategy as \u201chands-off\u201d.<\/p> Both ways involve some input from you but active investing involves either you or a professional adjusting your course regularly, while passive means setting your course and mostly sticking to autopilot. <\/p> At its core, active investing attempts to beat the returns of the market, whereas passive investing usually attempts to match or mirror market performance. But success is never guaranteed with either option.<\/p> A helpful metaphor to consider is driving a car and navigating yourself (active) vs using a sat nav (passive) to reach a destination (ideally, wealth!).<\/p> Of course, it\u2019s important to remember that when it comes to investing, you may not reach your desired destination at all. Whether you choose to invest actively or passively, you could end up with less money than the amount you put in. <\/p> With active funds, a dedicated fund manager tries to pick the best stocks. Passive funds, in contrast, simply seek to replicate an index, such as the FTSE 100 or the S&P 500.<\/p> In theory, most people like the idea of a clever human picking the best shares for them. However, quite often, they turn out not to be much better than the index and, at times, considerably worse.<\/p> Equally, active funds cost more, which acts as a drag on your returns over time. With this in mind, many people have concluded that the most straightforward way to invest is via a passive fund.<\/p> This is the main area that can set these strategies apart. Securities like passive broad-market exchange-traded funds (ETFs)<\/a> can be much cheaper than actively managed funds. <\/p> The difference may only appear small in percentage terms, but it can significantly impact the overall value of your portfolio<\/a> over time. <\/p> To give you an idea about costs, here\u2019s what a typical range of charges can look like with an example of each strategy:<\/p>Okay, can you give me some more detail?<\/h3>
A bit about ETFs<\/h3>
Why should I care about passive investing?<\/h3>
Active vs passive investing<\/h3>
Active vs passive funds<\/h4>
How do the costs of active and passive funds compare?<\/h4>
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