Passive Investing And Why You Should Care

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The Humble Guide To Passive Investing – Episode 1 – Passive Investing And Why You Should Care

 

Welcome to a new idea that I am calling The Humble Guide on this site.

These guides assume you’re on a money and life journey and exist to help you have a smooth and fun ride.

This first guide is focused on an important investment strategy called Passive Investing.

I expect that we’ll have about 10 episodes in this guide, and at the end of it, you’ll know all you need in order to gain confidence and start investing passively.

It’s fitting that this is the first guide on this site as I know so many people who want to invest but have absolutely no idea where to start.

You may have abit of money left over to invest each month.

However, what should you invest in? And how should you begin?

This is by far one of the biggest challenges for beginner investors. Then ofcourse, there is the perceived complexity, which in some cases can be justified.

Learning to invest is a necessary skill, which not only requires the need for knowledge, but also the need for a particular type of mindset.

It’s my desire that you’ll achieve the knowledge piece through this guide, whilst also forming the mindset piece as you start to put things into practice.

As you’ll know, if you set off on a journey to a specific destination, there are different paths you can take.

My preference is always to take the path of least resistance, offering me the best way of getting there, whilst also guaranteeing that I get to my destination in good time.

Passive investing is an investing strategy that offers such a path, and as such is most definitely worthy of your attention.

What Is An Investment Strategy?

I have previously written about the secret sauce for winning and covered the importance of the “POST” (Purpose Objectives Strategy Tactic) acronym.

There is definitely a way to win by investing and get rich through the process. However, to get started you have to choose an investment strategy.

The investment strategy is what guides your actions with regards to allocating your assets.

Strategies vary and it is important to note above that before there is any talk of strategy, there first need to be goals (or objectives) in existence.

Other factors that play a role in what type of strategy you might want to use to invest your money include your risk tolerance and your future need for your money.

Your investment strategy can help you either seek rapid growth in your capital i.e. important if you’re in the wealth accumulation phase of life.

Or it can help you focus on wealth protection i.e. important if you’re in the wealth preservation stage of your life.

Type Of Investing Strategies

Benjamin Graham in the brilliant investing book The Intelligent Investor identified five strategies for stock investing:

1. General Trading – This is the type of noisy activity you might hear your friends talk about. Some see as a way of making quick money. Here, you try to predict and participate in market movements.

2. Selective Trading – As an investor here, you pick stocks that you expect will do well in the market over the short term e.g. 12 months or less

3. Buying Cheap and Selling High – This is also a buy to hold strategy where you try timing the market. You pick stocks by buying cheap and selling high.

4. Long-pull selection – You pick stocks that you expect will grow quicker than others over a number of years.

5. Value Investing – These are bargain purchases where you essentially pick stocks that are priced below their true value.

This type of investing is what Warren Buffett does as he has a skill for valuing companies, and he has enough money to exert significant influence or control in any company that he invests in.

The common thing amongst all these strategies of investing is that you have to either pick stocks or delegate that decision to an investment manager.

This type of investing is known as active investing. The time, intellectual know-how and expertise that is put into stock picking come at a big price most of the time.

Worst still, a huge body of research shows that active investment managers do not outperform the market.

So why pick stocks or hire an expensive investment manager?

There are ofcourse the exceptions like Warren Buffett, who plays a totally different game as an active manager.

But guess what, he is the most famous supporter of the investment strategy you should be giving all your attention – passive investing.

In fact, to prove the point, he made a $1m bet in 2007/8 against a hedge fund (a type of active manager) that his passive investment in an index fund would do better than the outperformance promised by the hedge fund.

And 10 years later, he won the bet! There is an important lesson to be learned from this fun bet, and another reason why you should pay attention.

Related: Understanding Investment Fees And Why It Matters

What Is Passive Investing?

This is a type of investment strategy that aims to maximise your returns over a long period of time by keeping the buying and selling to a minimum.

This important because it avoids fees and drags on your future returns from frequent trading.

Essentially, it’s a buy-to-hold strategy that’s at the other end of the scale to what traders do.

Investors using this strategy are not interested in short-term market movements and most certainly are not timing the market.

A key assumption of passive investing is that given enough time, the market generates positive returns.

Passive investing is all about getting rich slowly, steadily and certainly over time.

Why Should You Care About Passive Investing?

Below are important reasons why this is an investment strategy you cannot ignore:

1. Simple And Easy

If you think investing is complicated, then you’re in for a treat with passive investing.

Not only do you completely do away with picking stocks, you also don’t have to worry about a single company going bust or market crashes happening.

Once invested, you simply step off and do nothing!

I recall reading once about some research about people who had done well over a long period of time investing.

Turned out that the best performers were either dead people or people who didn’t know how to log into their investing accounts!

You do have to go through the initial process of learning about jargon, but if you read Episode 2 in this series, you can learn all about it.

There is also the process of picking the funds you actually want to invest in to create a portfolio (a collection of your assets).

We’ll cover more on how to construct this portfolio in future episodes of The Humble Guide To Passive Investing.

Related: The A to Z of Money – Practical Definitions In Simple Terms

2. Low Cost

You’ll hear most people talk alot about performance when it comes to investing.

However, what not many people realise is that a big factor is this net performance are the costs that get knocked off your returns.

Costs (fees) is the number one reason why Warren Buffett won his bet against the Hedge Fund manager.

Passive investing as the name implies is passive and does not need ongoing tinkering. You really don’t need to pay “professionals” to do for you.

The savings, which translate into better net returns will be game changing over time and make you richer than you can imagine.

Note that you also don’t need alot of money to start investing passively. In fact, as little as £50 – £100 can get you going.

3. No Need To Time The Market

Whether the market is high or low, you need not care. You only need to invest consistently and step away.

Is Apple or Amazon cheap? You shouldn’t care if you are investing in a broad-based index fund that tracks the market.

4. Diversification

This is super important for managing the one thing most people are worried about – risk.

As written earlier, you only need to invest and allocate your assets across 6 or so funds to achieve sufficient diversification.

Diversification is referred to as the only free lunch in Finance. This is because you can reduce your risks without necessarily reducing your returns.

5. Performance

Passive Investing guarantees that you’re positioned to make the returns of the market.

This means that in some years, you could make positive returns and in others, you might make negative returns.

A broad-based index like the S&P 500 or FTSE 100 returns circa 7%+ per annum on average over say, 10 years.

Below is the performance of the FTSE 100 (Top 100 companies in the London Stock Exchange):

Below is the performance of the FTSE 250 (Next 250 companies in the London Stock Exchange):

The above is just for illustration, so show the performance post the 2008 Global Financial Crisis.

We’ll deal with portfolio construction in a later episode, however, the above generally points to what the extent of change in performance per year.

This picture will look completely different depending on the index (list) you’re looking at. e.g. S&P 500

6. Manage Your Own Money

With greater knowledge comes the confidence to manage your own money. Obviously, if you’re super rich, you can delegate alot of this stuff.

However, my experience is that I have learned so much from making the decision myself on how my money should be invested.

Passive investing gives you that opportunity to take the driving seat, although to honest, once you’re invested there isn’t alot more to do!

You’ll most certainly make mistakes because you’re human, but these are mistakes you’ll learn something important from.

7. Get Rich Slowly

In my philosophy for making good money, I highlighted the importance of getting rich slowly.

Given enough time and consistent investing, you’ll most certainly get rich if you allow your returns to feed the compounding machine.

However, note that you will not see this happening overnight. This passive investing game is a long one.

You will not make an overnight quick buck! This means you have all the time in the world to make mistakes and build your emotional discipline.

Your horizon should be at least 5 – 10 years. You should see the money you’re investing as locked away and untouchable (ideally).

Even if your horizon is not as long as the above, this should most certainly not stop you making the decision on how your assets should be allocated.

How Exactly Can You Invest Passively?

The best way to get started is to invest in index funds i.e. funds that track a particular index (a list of companies).

To learn more about this, you need to check out Episode 2 of the Guide.

Related:

• Investing Risks You Should Be Aware Of
• Books I Love (including investing books)
• 9 Smart Ways To Invest £1,000
• 4 Reason Why Holding Cash Is The Worst Thing To Do

What’s your experience of Passive Investing? Please comment below.

Do please share this post if you found it useful, and remember, in all things be thankful and Seek Joy.