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30th May 2019 | Flawiusz Pawluk | Financial Markets Expert

Pros and cons
​​​​​​​
of passive investing

Passive investing is an investment strategy whereby investment portfolios try and generate returns that mirror the returns of the main markets, main indexes or different assets classes i.e. developed markets, emerging markets, bonds, etc. Overall, passive portfolios may be built using several exchange-traded funds (ETFs), which track a different market index, like the S&P 500, thereby linking investors' performance directly to that of all of the companies in that market, rather than just one or two of them.

Key pros – why investors like passive investing

  • Low costs - passive investing directly through ETFs is the cheapest way to access the market, with typical ETF costs ranging from 0.1% to 0.2% annually. However, if you want to have a portfolio being built with more than one ETF, which will be managed daily, you need to take into account additional management fees. However, typically the total management fee for this kind of investment products are in the range of 0.5% and 0.8%, which is much below the average for the actively managed mutual funds (typically more than 1.0%, including in some cases additional so-called success fees).
  • Strong results in the long term - If you are prepared to invest your money over a long period of time (typically 10 years), the stock markets have historically delivered positive results. For instance, between March 2007 and March 2017, the FTSE 100 had returned 15.46% despite several prolonged periods of volatility. In addition to such a long horizon, passive investing delivers better results than active investing.
  • Simplicity and diversity - with a passive investment, you always invest in well-diversified products such as ETFs, which reduces the potential risk of investment. In addition, you do not have to know the fundamentals of the companies you invest in as you rather bet that the entire market moves up, not the particular company.

Key cons – why passive investing is not a perfect solution

  • Limited returns – with passive investments you will never beat the market – because ETFs are the market itself.
  • Volatility – ETFs remain volatile similarly to the regular stocks, however, given that in the recent years, the popularity of ETFs has increased, their volatility may increase in the future and enhance market fluctuations.
  • ETFs have not passed yet any bear market test – so we do not know how they will behave during a typical bear market. However, there is some material risk that significant redemptions of ETFs may increase the scale of drawdowns especially for the most liquid stocks, which usually constitute the major portion of the global market’s capitalization.

Conclusions

Over the past few years the passive investing has overshadowed active investing as the more efficient way of increasing personal wealth. However, this type of approach to the investment process evolved during the years of market prosperity. Therefore, the biggest test for passive investing is still ahead of us when bear market and higher volatility will take the focus. In addition, we must keep in mind that the ‘easy money’ policy implemented by FED after the market crash in 2008-2009, was very supportive for overall equity, bond markets and the implementation of new investment products.
Golden Sand Bank ("Bank") exercised due diligence to ensure that the information contained in this publication was not incorrect or untrue as at the date of publication.
All Investment products are at risk, as their value can go down as well as up. The tax treatment of your investment will depend on your individual circumstances and may change in the future. If you are unsure about whether investing is right for you, please seek financial advice. This publication is not an investment recommendation or investment advice in connection with any services provided by the Bank to the Client.

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