Passive investing is a popular strategy for people looking to grow their money over time. Instead of trying to pick winning stocks or guess market highs and lows, passive investing focuses on keeping things simple: Buy, hold, and follow the market. Here’s what to know about how it works and whether it may be right for you.
What is passive investing?
Passive investing is an approach where the goal is to match the performance of the broader market rather than trying to outperform it. Passive investors look to benefit from the market’s tendency to rise over the long term.
Because of this, passive investors most often put their money into funds—especially index funds that are designed to mirror a particular market benchmark. Buying individual stocks may still align with a passive investing strategy if you trade infrequently and hold your positions for extended periods.
Passive investing is often used by investors who want a low‑cost, low‑maintenance way to build wealth. It’s also commonly associated with passive income investing, because the investments can generate dividends or interest with little ongoing involvement.
How does passive investing work?
Passive investing is based on a simple principle: Markets tend to go up over time. Instead of trying to predict which stocks will rise and when that might happen, passive investors aim to capture the overall growth of the market.
This strategy often involves:
- Buying passive index funds or exchange‑traded funds (ETFs)
- Keeping trading to a minimum
- Staying invested through market ups and downs
- Focusing on long‑term results rather than short‑term movements
It’s an approach that can also help keep emotions out of the decision‑making process—like panic-selling during times of market volatility.
Active vs. passive investing
Active investing attempts to beat the market. Active investors research individual stocks, study market trends, and make frequent trades. Mutual funds managed by investment professionals can also be an example of active investing.
Passive investing, on the other hand, doesn’t try to outperform the market. Instead its goal is to mimic it, often by tracking an index (like the S&P 500®).
Key differences between active and passive investing:
| Active investing | Passive investing |
|---|---|
| Frequent trading | Buy-and-hold approach |
| Higher fees | Lower fees |
| Tries to beat the market | Tries to match the market |
| More potential for loss or gains | More predictable long‑term results |
| Requires research and constant monitoring | Requires much less maintenance |
Is active or passive investing better for returns?
Many investors use both strategies depending on their goals. Over long periods passive funds may outperform most active funds because of lower fees and fewer trading costs. Active investing can offer advantages in certain market conditions or for investors who want to be more involved.
Passive investment strategy
A passive investment strategy can be built around consistency and long‑term thinking. While there are many ways to put together a passive portfolio, strategies often include these elements:
Buy and hold
The buy‑and‑hold method is the backbone of passive investing. Instead of trying to time the market, investors purchase assets and keep them for years, sometimes decades. This approach helps smooth out short‑term volatility and can take advantage of long‑term market growth.
Funds
Most passive investors use passive index funds or index ETFs. These funds aim to mimic market indexes and are popular because they offer diversification, low fees, and easy access to broad parts of the market.
Examples include funds that follow:
- The S&P 500
- Dow Jones Industrial Average
- Bloomberg US Aggregate Bond Index
Robo advisors
For people who want an even more hands‑off approach, robo advisors may be an option to consider. They offer automated portfolios and select a mix of investments for you based on your goals. Robo advisors generally will also rebalance your investments and handle day‑to‑day management.
Advantages of passive investing
Passive investing can have several benefits, especially for long‑term investors:
- Lower costs: Passive index funds usually charge lower fees than actively managed funds.
- Simplicity: No need to regularly pick stocks or pay attention to day‑to‑day market movements.
- Diversification: Index funds spread your money across many investments, helping to reduce risk.
- Tax efficiency: Fewer trades can mean less complexity and liability at tax time by lowering the number of taxable events.
- Consistent long‑term performance: While no strategy guarantees returns, passive investing may match long-term market growth (minus any fees).
- Less emotional decision-making: Infrequent trading gives you less opportunity to make impulsive decisions, especially in times of market volatility.
Disadvantages of passive investing
The potential downsides of passive investing include:
- Little chance to outperform the market: Returns tend to align with what the market does overall, minus fees.
- Limited flexibility: You can’t adjust funds based on market conditions or personal insights—with individual stocks you can buy or sell whatever you like.
- Market risk: Passive investments lose value if the overall market drops, and there is no certainty when or if it will bounce back.
- May feel slow to some investors: Those looking for quick gains may find passive investing less exciting.
Passive investment income
Passive investors typically make money through a combination of long‑term price increase and any dividends or interest generated by the investments they hold.
Passive investing can help build passive investment income through:
- Dividends from individual stocks or stocks in an index fund
- Interest from individual bonds or bonds in a fund
Passive investing may often be part of a long‑term plan to generate passive income or supplement retirement income.
Read more: How to make passive income
Passive investing fees
A big appeal of passive investing is low fees. Index funds usually have lower expense ratios than actively managed funds because they don’t require teams of analysts making constant trading decisions.
Lower fees can really add up over time, allowing for more potential investment growth to stay in your pocket.
Who can benefit from passive investing?
Passive investing may be well suited for:
- Beginners who want a simple way to start investing
- Long‑term investors saving for retirement
- People who don’t want to monitor the market every day
- Anyone looking for a low‑cost and/or tax-efficient portfolio
- Investors focused on steady growth rather than rapid gains
Passive investing can be beneficial to just about anyone. Even experienced traders and investors may often use passive funds as the base of their portfolio.
How to get started with passive investing
Here are a few simple steps to begin passive investing:
- Decide on your long‑term goals.
- Choose an investment account (like brokerage or IRA).
- Select one or more passive index funds or index ETFs to invest in.
- Look into using a robo advisor like Fidelity Go® if you prefer full automation.
- Consider setting up automatic contributions or recurring investments.
Lastly, be patient and stick to your plan—even during market ups and downs.