Passive portfolio management is a term you may have heard thrown around in the investment world, but what does it actually mean?
In short, passive portfolio management is a way of managing a portfolio in which the investor takes a hands-off approach. This type of management style is growing in popularity as investors become more and more aware of its benefits.
In this article, we will discuss what passive portfolio management is and how it works. We will also take a look at some of the key features that make it so popular, as well as the types of assets that are typically invested in through this strategy. Finally, we'll give you an example to help illustrate how it all comes together.
What is passive portfolio management?
Passive portfolio management is a strategy that involves minimal active trading of securities. The goal is to mirror or track a market index, such as the S&P 500, by holding all or most of the securities in that index. Passive portfolio investors tend to invest for the long term, and they might even use a strategy like dollar-cost averaging (DCA) to constantly add to their positions.
What are the features of passive portfolio management?
The main feature of passive portfolio management is its low turnover rate. This means that there will be fewer trades made, and therefore fewer transaction costs incurred, than with an actively managed portfolio.
In addition, because the aim is to simply match the performance of an index, there is no need for extensive research and analysis. This means that passive portfolio management can be less time-consuming than other investment strategies.
Another key feature of passive portfolio management is that it often leads to greater diversification. This is because, to track an index, investors typically need to hold a large number of different securities.
Finally, passive portfolio management tends to be more tax-efficient than active investing, since there are fewer capital gains taxes incurred. Passive portfolios are also tax-efficient because they are commonly held in retirement accounts, such as IRAs and 401(k)s.
What type of assets do passive portfolio managers invest in
Typically, passive managers invest in large-cap stocks, as these are the stocks that make up the majority of most indexes. However, passive managers may also invest in other asset classes, such as bonds, real estate, and commodities.
For example, let's say you want to track the S&P 500 index. To do this, you would need to buy shares in each of the 500 companies that make up the index. This would give you a well-diversified portfolio of large-cap stocks.
Now, this would be time-consuming. That's why it may be better to invest in an index fund, which is a fund that holds all or most of the securities in a particular index. Index funds are available for a wide range of indexes, including the S&P 500, and can be a good way to passively invest in the market.
Passive portfolio managers can also track specific sectors such as the energy sector, or they can choose to invest in international markets. Now that we've answered some of the key questions about passive portfolio management, let's take a look at an example to see how it works in practice.
Passive portfolio management example
ETFs (exchange-traded funds) are the most popular type of investment for passive portfolio management. With ETFs, you can get exposure to a wide variety of underlying assets, including stocks, bonds, commodities, and more. And because they trade on an exchange like stocks, you can buy and sell them any time during market hours.
For example, some of the most famous ETFs are the SPDR S&P 500 ETF (SPY) and the Invesco QQQ Trust (QQQ). These two ETFs track the performance of the S&P 500 Index and the Nasdaq-100 Index, respectively. If you want to build a passive portfolio, you can start by investing in a couple of these well-known ETFs.
But remember, you don't have to limit yourself to just these two. There are thousands of ETFs out there, so you can find ones that track any kind of underlying asset or index that you're interested in.
Another popular option for passive portfolio management is index funds. Index funds are similar to ETFs in that they offer exposure to a wide variety of underlying assets. However, unlike ETFs, index funds are not traded on an exchange. Instead, they are bought and sold directly through the fund company.
For example, the Vanguard 500 Index Fund (VFINX) is one of the most popular index funds out there. It tracks the performance of the S&P 500 Index, just like the SPY ETF. If you're interested in building a passive portfolio, index funds are another great option to consider.
Is passive portfolio management right for you?
If you are hands-off when it comes to your investments and you don’t want to spend time actively managing your portfolio, then passive portfolio management may be a good fit for you.
With passive portfolio management, also known as passive investing, you will develop and stick to an investment strategy and then let that strategy play out over time. This means that you are not regularly buying and selling stocks or making other changes to your portfolio.
As mentioned above, there are a few different approaches that you can take with passive investing. One is to simply invest in an index fund that tracks a specific market index, such as the S&P 500. In this scenario, the company that manages the index fund will do the work of buying and selling stocks on your behalf.
Another approach is to choose individual stocks or other investments and then hold onto them for the long term. You would be considered the passive portfolio manager for your investments in this case. However, you are technically not a professional passive portfolio manager because you are not managing anyone else’s money.
The bottom line is that passive portfolio management can be a good fit for hands-off investors who don’t want to actively manage their portfolios. If you choose to be the passive portfolio manager for your own investments, just be sure to do your research before making any decisions.