Are you curious about stock market investing, but don’t know where to begin? Passive investing in the stock market is the most popular choice for beginners. Why? Because it’s easy and requires less time and effort than active investing. If you’re aiming for a “set and forget” approach, especially for long-term goals, passive investing is your go-to strategy. If you want to learn more about this simplified path to stock market success, keep reading!
Key takeaways
- Passive Investing Simplifies Stock Market Entry: Passive investing is favored by many beginners in the stock market due to its simplicity and lower time commitment compared to active investing.
- Long-Term Strategy: Passive investing is ideal for individuals with long-term financial goals who prefer a “set and forget” approach, allowing investments to grow over years or even decades.
- ETFs Provide Diversification: Exchange-traded funds (ETFs) offer a simple way to invest in a diversified portfolio of stocks, providing exposure to various market sectors while minimizing risk.
- Dividend Reinvestment Plans (DRIPs): Many stocks in ETFs offer dividends, which can be reinvested through dividend reinvestment plans (DRIPs), leveraging the power of compounding for increased portfolio value over time.
- Index Funds Track Market Performance: Index funds, like the S&P 500 index fund, track the performance of the broader market or specific sectors, providing investors with exposure to a wide range of companies.
- Listed Investment Companies (LICs): LICs offer exposure to a basket of securities and are actively managed, providing investors with an alternative to ETFs but typically incurring higher fees.
- Fixed Income Funds Offer Stability: Fixed income funds, such as government or corporate bonds, generate regular income for investors and are considered lower risk compared to equity funds, making them suitable for those seeking steady income or nearing retirement.
- Commodity and Currency Funds: These funds allow investors to gain exposure to commodities or currency markets without physically owning the assets, providing diversification benefits but also carrying higher risk due to market volatility.
- Real Estate Funds: Real estate investment trusts (REITs) and other real estate funds offer exposure to the property market without the hassle of property management, providing stability but also subject to market conditions.
- Specialty Funds for Niche Investments: Specialty funds invest in specialized assets or securities, such as socially responsible investing or hedge funds, offering diversification but typically carrying higher risk and requiring a deeper understanding of the market.
- Education and Research are Key: Understanding the different types of passive investing options, underlying assets, and market conditions is crucial for making informed investment decisions. Books and resources tailored to passive investing can provide valuable insights for beginners and seasoned investors alike.
Out of all types of investing in the stock market, passive investing in the stock market is the most popular amongst people new to investing. This is because passive investing requires less time and effort to manage compared with active investing. For long-term investors, passive investing can be considered the “set and forget” approach.
There are many passive investing options available to investors nowadays due to their popularity. Because of the number of choices, passive investing in the stock market does require some upfront research. Here we discuss some of the more common passive investing types to get you started.
Exchange-traded funds (ETFs)
Exchange-traded funds (ETFs), as their name suggests, are funds (a diversified basket of assets) that can be traded on the stock exchange.
A common passive investing strategy is to buy a diversified group of stocks through an ETF and leave them for years, or even decades, to grow in value.
If you’re looking to learn about ETF investing, A Beginner’s Guide to the Stock Market by Matthew R. Kratter (Link*) is an excellent choice. This highly rated book has received great reviews, making it a must-read for anyone looking to get started in the stock market.
Many stocks in ETFs also pay dividends that can be reinvested. Reinvesting dividends into the fund through dividend reinvestment plans unlocks the power of compounding, further increasing the value of your portfolio.
If you’re interested in creating passive income and achieving financial freedom through dividend investing, look no further than Dividend Investing: The Beginner’s Guide to Create Passive Income and Achieve Financial Freedom with Stocks by Henry Cooper (Link*).
Even the legendary investor Warren Buffett – chair and CEO of Berkshire Hathaway Inc., recommends ETFs for investors who don’t have the time or skills to manage their investment portfolios actively.
ETFs come in various categories, mostly differing in the asset classes they cover. The most popular of these are index funds and listed investment companies.
Index funds
Index funds track the broad market or market sectors. These are the most common ETFs.
Warren Buffet’s recommendation is the S&P 500 index fund.[1] This ETF covers the largest 500 companies in the United States by market capitalization.
Many fund issuers in the US include the S&P 500 index in their listings, such as the Vanguard S&P 500 ETF (ticker: VOO) and the BlackRock iShares S&P 500 ETF (ticker: IVV).
Similar index funds can be bought and sold on other exchanges, including the ASX200 in Australia and the FTSE300 in the UK.
The Bogleheads’ Guide to the Three-Fund Portfolio: How a Simple Portfolio of Three Total Market Index Funds Outperforms Most Investors with Less Risk by Taylor Larimore (Link*) is a short, easy-to-read guide that describes the most popular index fund portfolio on the Bogleheads forum. The foreword in this book is written by John “Jack” Bogle, credited with creating the index fund and founder of The Vanguard Group.
Listed investment companies (LICs)
Listed Investment Companies (LICs) provide exposure to a basket of underlying securities that can include shares and other asset classes. They are a closed-end collective investment scheme in Australia[2], similar to investment trusts in the UK and Japan, and closed-end funds in the US.
LICs are similar to ETFs in that they can be traded on the share market as a basket of shares. However, they differ in that they are actively managed, whereas ETFs can be passively or actively managed. Actively managed funds generally incur higher fees compared with passively managed funds. Because of this, it is important to research the fees associated with any fund you are considering adding to your investment portfolio.
Despite being actively managed, LICs are considered passive for investors because they can be bought and sold on the stock market the same way as individual companies or ETFs.
The three largest LICs in Australia as at Nov 2023[3] are:
- Australian Foundation Investment Company Ltd (AFI), with a market cap of approximately AU$8.7 billion,
- Argo Investments Ltd (ARG), with a market cap of approximately AU$6.4 billion, and
- Wilson Asset Management Leaders Limited (WAM), with a market cap of approximately AU$1.7 billion.
These three LICs invest primarily in Australian equities, along with the majority of other LICs. Some LICs invest in global equities, fixed income (AU$) (e.g. MXT), and global property (e.g. FPP).
Fixed income funds
Fixed income funds are a type of investment that pools money from multiple investors to buy a diversified portfolio of fixed income securities, such as bonds. These securities are issued by governments, municipalities, and corporations and pay a fixed rate of interest to the bondholder until maturity.
Fixed income funds generate regular income for investors through the interest payments received on the bonds held in the fund’s portfolio. The interest payments are usually paid out on a quarterly basis.
The different types of fixed income funds include government bonds, corporate bonds, municipal bonds, and Treasury bonds. Each type of bond carries its own set of risks and returns. Government bonds are considered to be the safest, while corporate bonds are considered to be higher risk but can yield higher returns. Additionally, the value of the fund can fluctuate based on the interest rate changes in the market.
Fixed income funds are generally considered to be lower risk than equity funds, as the value of the bonds held in the fund’s portfolio is less likely to fluctuate as much as the value of stocks. However, the long-term returns on fixed income funds are also generally lower than those of equity funds.
Investors looking for a steady income and lower risk should include fixed income funds in their investment portfolio. They are particularly suitable for investors nearing retirement or looking for a reliable source of income.
If you are looking for an easy to understand book with valuable information on bond investing, check out Step by Step Bond Investing: A Beginner’s Guide to the Best Investments and Safety in the Bond Market (Step by Step Investing) by Joseph Hogue (Link*).
Commodity funds
Commodity funds are a type of investment that includes a diversified portfolio of commodities, such as gold, oil, and agriculture products. These types of funds allow investors to gain exposure to the price movements of the underlying commodities without having to physically own them.
The main objective of commodity funds is to generate returns through the increase in the prices of the commodities held in the fund’s portfolio.
Common commodity funds include precious metals, energy, and agriculture funds. Precious metals such as gold are considered to be a safe haven asset, while energy funds may be affected by political and economic events.
The value of commodity funds can fluctuate based on the type of commodity. For example, supply and demand of precious metals, weather conditions can affect agriculture-based funds, and geopolitical events can affect energy-based funds.
Commodity funds are considered to be higher risk than fixed income and equity funds, as the prices of commodities can be highly volatile. However, they can also provide diversification benefits to an investment portfolio and can generate returns that are not correlated with the stock and bond market.
It’s important to note that investing in commodity funds requires a good understanding of the underlying commodities and the market conditions that can affect their prices.
Currency funds
Currency funds are funds that allow investors to gain exposure to the price movements of different currencies without having to physically own the currencies. The main objective of currency funds is to generate returns through the changes in the exchange rates of the currencies held in the fund’s portfolio.
A few different types of currency finds include developed market currencies, emerging market currencies, and specific currency funds. Developed market currencies such as the US dollar, Euro, and Japanese yen are considered to be more stable, while emerging market currencies may be affected by political and economic events.
The value of currency funds can fluctuate based on interest rate changes, geopolitical events, and economic indicators that can affect the exchange rates.
Currency funds are generally considered to be higher risk than fixed income or equity funds, as the exchange rates can be highly volatile and affected by a wide range of factors.
The main advantage of owning currency funds is that they can provide diversification benefits to an investment portfolio and can generate returns that are less correlated with the stock and bond markets.
Real estate funds
Real estate funds are usually managed in real estate investment trusts (REITs). A real estate investment trust is a company that owns, operates, or finances income-generating real estate.[4] Common types of real estate held in REITs include commercial (e.g. office buildings, shopping malls and hotels) and private (e.g. apartment complexes). Many investors find it easier to invest in REITs instead of owning physical property. This is because they can own shares in REITs for less outlay. In addition, REIT investors don’t need to spend time managing the properties.
The main objective of real estate funds is to generate returns through the increase in the value of the properties held in the fund’s portfolio and through rental income.
Real estate funds can be further categorized into different types such as REITs (Real Estate Investment Trusts), private equity real estate funds and real estate development funds. Each type of real estate fund carries its own set of risks and returns. For example, REITs are required to distribute a high percentage of their income to shareholders, while private equity funds may have a longer investment horizon and more concentrated holdings. Additionally, the value of the fund can fluctuate based on the real estate market conditions, interest rate changes, and economic indicators that can affect the property values.
Real estate funds are considered to be a more stable investment than equity funds, as the real estate market tends to be less volatile than the stock market. However, the returns on real estate funds can be affected by supply and demand, changes in interest rates, and economic conditions.
Specialty funds
Specialty funds are funds that comprise securities or assets that are specialized or niche in nature. These types of funds can invest in a wide range of assets such as social impact investing, environmental, social, and governance (ESG) investing, and hedge funds. The main objective of specialty funds is to generate returns through the performance of the specialized assets or securities held in the fund’s portfolio.
Examples of specialty funds include socially responsible investing funds, impact investing funds, and hedge funds. Each type of specialty fund carries its own set of risks and returns. For example, socially responsible investing funds may have a higher risk-return profile than impact investing funds which may focus on specific themes such as renewable energy or affordable housing. Additionally, the value of the fund can fluctuate based on the performance of the specialized assets or securities in the fund’s portfolio.
Specialty funds usually carry a higher risk than traditional funds, as the specialized assets or securities held in the fund’s portfolio may be more volatile or illiquid. However, they can also provide diversification benefits to an investment portfolio and can generate returns that are not correlated with the traditional market.
Some specialty funds, such as inverse funds, increase in value as the general market decreases in value. Other specialty funds include leveraged funds that aim to perform better than the market by using leveraged assets.
Final thoughts
If you are unsure where to start with passive investing in the stock market, Investing QuickStart Guide: The Simplified Beginner’s Guide to Successfully Navigating the Stock Market, Growing Your Wealth & Creating a Secure Financial Future by Ted D. Snow is an excellent book for beginners through to seasoned investors. Ted is a certified financial planner with over 30 years of investment experience. This book covers all of the different types of passive investing covered above, plus more! (Link*)
It’s important to note that investing in any type of fund requires a good understanding of the underlying assets, whether they are equities, bonds, currencies, commodities, or real estate.
Additionally, understanding the market conditions that can affect the different asset types is important. Natural disasters, geopolitical events, real estate market conditions, and interest rate changes can affect the performance of various asset classes.
As with any financial decision, it is important to research and seek advice on the various types of passive investing options available to you.
FAQs
1. What is passive investing in the stock market?
Passive investing in the stock market involves investing in a diversified portfolio of assets and holding them for the long term, with minimal buying and selling activity. This strategy aims to track the performance of a specific market index or sector, rather than trying to outperform the market through active trading.
2. How does passive investing differ from active investing?
Passive investing involves buying and holding a diversified portfolio of assets to match the performance of a specific market index or sector. In contrast, active investing involves frequent buying and selling of securities in an attempt to outperform the market through skillful stock selection and market timing.
3. What are some common passive investing options available in the stock market?
Common passive investing options include exchange-traded funds (ETFs), index funds, listed investment companies (LICs), fixed income funds, commodity funds, currency funds, real estate funds, and specialty funds.
4. How do ETFs work in passive investing?
ETFs are funds that can be traded on the stock exchange and typically track the performance of a specific market index or sector. Investors can buy shares of an ETF, which represents ownership in a diversified portfolio of assets, and hold them for the long term to achieve market returns.
5. What are the benefits of passive investing?
Passive investing offers several benefits, including lower fees, reduced time and effort required for management, diversification, and the potential to achieve market returns over the long term. It is especially suitable for investors with long-term financial goals who prefer a hands-off approach to investing.
6. What are the risks associated with passive investing?
While passive investing is generally considered lower risk compared to active investing, it is not without risks. Market fluctuations, economic downturns, and changes in interest rates can impact the performance of passive investments. Additionally, investors may be exposed to specific risks associated with the underlying assets of their chosen passive investment options.
7. How can I get started with passive investing in the stock market?
To get started with passive investing, investors can research and select a suitable passive investment option based on their financial goals, risk tolerance, and investment preferences. It’s important to educate yourself about the different types of passive investments available, understand their underlying assets, and consider consulting with a financial advisor for personalized advice.
More resources on passive investing in the stock market for wealth building
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- A Beginner’s Guide to the Stock Market by Matthew R. Kratter Link*
- Dividend Investing: The Beginner’s Guide to Create Passive Income and Achieve Financial Freedom with Stocks (Stock Market Investing Book 2) by Henry Cooper Link*
- Investing QuickStart Guide: The Simplified Beginner’s Guide to Successfully Navigating the Stock Market, Growing Your Wealth & Creating a Secure Financial Future by Ted D. Snow CFP MBA Link*
- The Bogleheads’ Guide to the Three-Fund Portfolio: How a Simple Portfolio of Three Total Market Index Funds Outperforms Most Investors with Less Risk by Taylor Larimore Link*
- Step by Step Bond Investing: A Beginner’s Guide to the Best Investments and Safety in the Bond Market (Step by Step Investing) by Joseph Hogue Link*
- Real Estate Investment Fund: How to Chose a SMART Real Estate Investing Fund: Top 10 Biggest Mistakes To Avoid Before Investing Into a Real Estate Fund (Private Money, REITS, Equity, Structure, Tax) by Mike Zlotnik Link*
- Investing for Kids: How to Save, Invest and Grow Money by Dylin Redling Link*
- DIVIDEND INVESTING FOR BEGINNERS: Build your Dividend Strategy, Buy Dividend Stocks Easily, and Achieve Lifelong Passive Income (BONUS: Living Off Your … Books: Investing in Bear Markets Book 1) by G. R. Tiberius Link*
- Investing for Passive Income: Get Up to 10% Dividends Each Year and Make Money for Retirement with Dividend Growth Stocks, MLPs and REITs by Freeman Publications Link*
(*) This site contains affiliate links to products. We may receive a commission for purchases made through these links at no extra cost to you. Please read our affiliate links disclosure for more information.
