Passive investing: A beginner’s guide to building wealth

Everything you need to know about passive investing and how it helps you build wealth.
EXPLORE FUNDS
4 mins
4 Nov 2023

Passive investing is a long-term investment strategy that aims to maximise returns by minimising buying and selling. Unlike active investing, which involves frequent trading and attempts to outperform the market, passive investing involves buying and holding a diversified mix of assets to match, not beat, the market. The most common passive investing approach is to buy an index fund, whose holdings mirror a segment of the financial market.

Types of passive investing

There are several types of passive investing strategies that investors can use to build wealth over time. Here are some of the most popular ones:

  1. Index funds: Index funds are mutual funds or exchange-traded funds (ETFs) that track a specific market index, such as Sensex or Nifty. They are designed to replicate the performance of the index they track and offer investors broad exposure to a particular segment of the financial market.

  2. Exchange Traded Funds (ETFs): ETFs are a type of passive fund that tracks the performance of an underlying index. An ETF is a portfolio that closely resembles an index. ETFs don’t try to outperform their benchmark indexes. Furthermore, ETFs trade on the stock exchange, and thus one can buy and sell ETFs on the exchange. As a result, the ETF prices fluctuate throughout the day.

  3. Fund of Funds (FOFs): FOFs are mutual funds that invest in other mutual funds. They are designed to provide investors with a diversified portfolio of funds. FOFs can be actively or passively managed.

  4. Smart beta: Smart beta funds are similar to ETFs in many ways. They combine the benefits of passive funds with the selection of active investments based on certain criteria. This allows the fund to generate higher returns using a cost-effective model.

On one hand, smart beta funds follow the underlying index when it comes to performance. On the other hand, they make changes to their portfolios based on market movements. Like ETFs, smart beta funds lack fund manager bias.

How does a passive investing strategy work?

Passive investing revolves around choosing a market index and forming its replica by investing in the same stocks in a similar proportion as done by the index. After that, the fund starts tracking the index closely and making changes to the portfolio as per the underlying index to make the fund closely identical to the index. When it comes to passive funds, there is no process related to selecting stocks, as the stocks of these funds are like that of their underlying indices. Therefore, fund managers play a limited and passive role, which is the ultimate meaning of passive funds.

Pros and cons of passive investing

Like any investment strategy, passive investing has its benefits and disadvantages. Here’s a quick look at both:

Pros

Cons

Low expense ratio

Limited flexibility

Diversification

No opportunity for outsized returns

Easy execution

No protection against market downturns


How can you invest in passive funds?

Investing in passive funds is relatively easy on the Bajaj Finserv platform. Just select the mutual fund scheme you want to invest in and follow these steps:

• Step 1: Click on INVEST NOW. You will be redirected to the mutual funds listing page.
• Step 2: Filter by scheme type, risk appetite, returns, etc. or choose from the top performing funds list.
• Step 3: All the mutual funds of the particular category will be listed, along with the minimum investment amount, annualised return, and rating.
• Step 4: Get started by entering your mobile number and sign in using the OTP.
• Step 5: Verify your details using your PAN, date of birth.
If your KYC is not complete, then you will have to upload your address proof and record a video.
• Step 6: Enter your bank account details.
• Step 7: Upload your signature and provide some additional details to continue.
• Step 8: Choose and select the mutual fund that you want to invest in.
• Step 9: Choose whether you want to invest as SIP or lumpsum and enter the investment amount. Click on ‘Invest Now’
• Step 10: Select your payment mode i.e., net banking, UPI, NEFT/ RTGS.
• Step 11: Once your payment is done, the investment will be complete.

Your investment will start reflecting in your portfolio within 2-3 working days.x

Passive investing is an investment strategy that aims to maximise returns by minimising buying and selling. It involves buying and holding a diversified mix of assets to match the market. While there are pros and cons to this investment strategy, it can be an effective way for investors to build wealth over time with minimal effort.

Frequently asked questions

Why is passive investing better for investment returns?

Passive investing, often through passive mutual funds, is a strategy that aims to maximise returns by minimising buying and selling. It’s considered better for investment returns due to its lower costs and simplicity. Passive funds typically have lower expense ratios, which can lead to better returns for investors. Moreover, passive investing is a long-term strategy that avoids the fees and limited performance that may occur with frequent trading.

Is passive investing a bubble?

Whether passive investing is a bubble is a topic of debate. Some believe that the inflated price of stocks due to high levels of passive investment into index funds distorts the true market value. However, others argue that the current situation cannot be described as a “passive investing bubble” as they believe a high price to earnings ratio is mainly driven by bullish market sentiment rather than inflows to passive funds.

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Disclaimer

Bajaj Finance Limited (“BFL”) is a Non-Banking Financial Company carrying the business of acceptance of deposits, providing lending solutions to Retail & Corporate customers, and is a Corporate agent of various insurance Companies. BFL is also registered with the Association of Mutual Funds in India (“AMFI”) as a distributor of third party Mutual Funds (shortly referred as ‘Mutual Funds’).

BFL does NOT:

(i) provide investment advisory services in any manner or form;

(ii) perform risk profiling of the investor;

(iii) carry customized/personalized suitability assessment;

(iv) carry independent research or analysis, including on any Mutual Fund schemes or other investments; and provide any guarantee of return on investment.


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