BUSTING MYTHS ABOUT PASSIVE INVESTING
There are numerous ways to accumulate wealth, and investing in stocks, bonds, and other assets that generate passive income is just one of them. However, for one reason or another, some people remain skeptical of passive income strategies due to some myths. Unfortunately, it is these myths and misconceptions that keep many investors from realizing truly passive income and potentially limitless wealth creation opportunities.
In this article, we debunk 6 myths you probably believed about passive investing, just because we don't want you making wrong decisions. Enjoy the read!
6 MYTHS YOU BELIEVED ABOUT PASSIVE INVESTING
1. Passive Investing Is Risk-Free
We all know that passive investing does not involve active stock selection and instead simply mirrors the index. As a result, fund management incurs fewer expenses, resulting in a lower expense ratio. However, just because a passive instrument does not involve active fund management does not imply that it is without risk.
Systematic risks exist in equity markets. They could be economic cyclicality, political or geographical risks, currency risks, interest rate risks, and so on. These risks have an impact on the market and are mitigated through prudent asset allocation and diversification.
2. Passive Investing Is Only Appropriate During Bear Market Periods
Active investing seeks to generate alpha, or returns that exceed the market return, through active stock selection. When the stock market is on a roll, everyone looks to active investing to generate additional returns while dismissing passive investing. Like passive investing, the beauty of a long-term buy-and-hold strategy is its ability to weather ups and downs while still producing decent returns for investors.
3. Passive Investing Is Only For Beginners
Passive investing is ideal for those who want to keep investing without actively monitoring their portfolio. It is also appropriate for cost-conscious investors and those who are hesitant to take the risks associated with fund manager selection. So no, it's not only for beginners.
4. Passive Investing Is Rigid
Who says? If you only invest in one ETF, your passive investment strategy is rigid. However, by diversifying across ETFs, you can achieve the required level of flexibility.
Although you cannot change the stocks in an ETF, if you want to invest in a specific stock, you can simply buy it and hold it for the long term. After all, the point of passive investing is to keep your investments for the long term rather than churning your portfolio frequently. You can achieve a mix of passive investing and flexibility by creating a minor case of the stocks you want to invest in.
5. Passive Investing Restricts Portfolio Diversification
Because passive funds track an index, they provide broader market access. There are also passive funds that track international indices and funds that provide geographical diversification to the portfolio. Furthermore, sectoral ETFs can provide sectoral exposure at a lower cost.
6. Passive Investing Yields The Same Returns As The Index
Passive investing instruments, in theory, produce the same returns as the index. However, there may be times when a passive fund cannot match index returns due to a variety of factors such as an index fund's need to hold cash for redemptions, mutual fund expenses, or an inability to purchase a stock at the same price as the index.
Because of these factors, the performance of passive funds may differ from that of their underlying index. This difference is known as tracking error, and it is one of the metrics to consider when selecting a passive fund.
These are just a few of the many investing myths that have spread throughout the investing world. While both active and passive investing are effective strategies, the advantages of passive investing should not be overlooked. It is a low-cost, low-churn, and low-volatility way of accumulating wealth over time.