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What is Passive Investing and How Power of Compounding Helps Passive Investing?

dateKnowledge Centre Team dateSeptember 29, 2022 views101 Views
Compounding Interest | Compound Interest and Inflation

With automated technology that helps you in creating and implementing strategies on passive earnings, it’s far easier to invest your money at right time in the right financial instrument. However, with new technology, you can understand these systems within hours and use the technology to invest perfectly. This passive earning requires minimum if not zero effort. Let’s find out more about, “What is passive investing?”

What is Passive Investing?

Predicting market movement and searching for the companies that will outperform others is not something smart investors would want to do. If you are employed or self-employed, have a job or a business to run and a family to look after. Investing and growing should be one part of your life that should run on auto-mode.

Establishing this growth process for your money is what is called passive investing.

Passive investing is a type of investing strategy in which you invest in an index to maximize returns while minimizing the effort. This means you don’t have to constantly monitor the market trends and buy or sell frequently. It’s a long-term buy-and-hold investment strategy as known by the world.

Active Vs Passive Investing

Active and Passive Investing surely are different from one another. While there is so much to describe the two, we have summarized the difference between them in an easy-to-understand table.

Active Investing Passive Investing
Investing in individual companies Investing in a group of stocks
Performance dependent on individual stocks Performance dependent on a group of stocks
Costly Affordable
Needs a portfolio manager No need for special managers
Frequent Buying and Selling needed No need to Buy and Sell frequently
Short Term Long-term, Buy-and-hold
Thorough research required Can be invested in with minimum research

Advantages of Passive Investing

Although active investment can provide you with huge returns, it completely depends upon your investment timings. If the manager you hire doesn’t call off buying or selling at the right time, you might lose a huge chunk of profit in a short period. That’s why passive investing is seen as a generally more successful option.

Knowing, “What is Passive Investing?” isn’t enough. Let’s look at the advantages that Passive Investing can provide you with.

1. Steady Earning

Investing in Passive Funds means you’re in it for a long race. As we all have heard at least once in our life, ‘Slow and steady wins the race.’ It’s seen that Passive Funds surely outperform Active Funds in a longer race. According to statistics, only 25% of Active Funds beat Passive Funds in 10 years.

2. Fewer Efforts

As one of the most known benefits of passive investing, low maintenance is something that active investing surely lacks. After investing in Active Funds, you must monitor fluctuations and price changes constantly. Passive Funds don’t need that, as they are long-term, buy-and-hold investment strategies. You also don’t need to keep checking for buy and sell signals constantly.

3. Affordable

Active investment needs a manager who will charge loads of money for their services. Passive investing cuts off the middleman and helps you save money. As very less effort is required any services you take will also cost very less.

4. Lower Risk

Passive investments work as an index of stocks. This index performs as a group and that’s why a bad-performing stock cannot affect your returns individually. This lowers the risk to a huge degree.

5. Saving on Capital Gain Tax

Every time you sell an asset to earn a profit, you must pay capital gain tax. While you invest in passive funds, these taxes can be lowered. As you know that passive investments are held for a longer term, you don’t sell as frequently. This helps you on saving the tax that active investors pay frequently.

Passive Investing and Power of Compounding

Passive investments are powered by compounding. Since you stay in for a long time and investments can earn interest on interest the effect of compounding is exponential. This is also the core principle of passive investing. Where the interest your capital investment earns works to earn more interest.

For example, if you invested Rs 1000 in an investment which earns a 5% compounded return per year, it’ll earn Rs 50 as interest in the first year. In the second year, even Rs 50 will earn interest at 5% thus, you will have Rs 52.5 as interest in the second year and so on.

Now that you know the answer to, “What is Passive investing?” and “What power does Compound interest hold?” You are ready to go and earn loads of money in long-term investments.

Must Read - Compound Interest Investment

Passive Investment Options in India

Passive investments are the mainstay of your financial life. Here are a few passive investment options in India that can comfortably grow your money:

1. Exchange Traded Funds (ETFs)

ETFs are a diversified portfolio of commodities like gold, silver, equity stocks or bonds. ETFs offer the benefits of passive investing such as:

  • No maximum investment terms
  • Earnings on invested funds are reinvested regularly (usually once every quarter)
  • Both dividends and capital gains are reinvested
  • The fund follows the price of a commodity or stock index, which means that even if you are selling your units the ETF may not sell the securities
  • Higher liquidity as units can be sold on an exchange

2. Index Funds

Index funds behave very much like ETFs with the only difference being the lack of an exchange trading option. Index funds are one of the pure passive investments available as these funds are expected to only mimic an established stock index such as Nifty 50, or BSE 30.

The only time an index fund will sell a stock and buy another is when it is replaced in the underlying index.

3. Diversified Funds

Diversified mutual funds invest in diversified securities or stocks or bonds. The purpose of buying a security in the fund is to hold it for dividend and capital growth for a long time.

Diversified funds may enter or exit security after thorough research and only when their fundamentals are not comparable to the fund objective.

4. ULIP with Diversified Equity Funds

ULIPs are life insurance plans with major investment features. You can invest in an Index fund, diversified fund (both equity and debt) or even invest in active funds like sectoral and value funds.

Thus, with ULIPs as well you can start passive investing. Also, because ULIPs are compulsorily long-term they offer better discipline and compounding benefits for your savings.

Unit Linked Insurance Plans

Apart from passive investing ULIPs like Invest 4G from Canara HSBC Life Insurance offer the following benefits:

  • Tax saving on invested money
  • Tax-free growth and withdrawals after 5 years of investment
  • Bonus additions for long-term investors
  • Life cover for family members

All these funds can give you great returns on long-term investments. The power of compounding works best with long-term passive investments. Thus, if you are investing in one of these investments you need to have a long-term vision in mind.

Passive Investing is a great tool to earn long-term profit that can be used for your future. Investing in Passive Funds is easier, cheaper, and safer. That’s why there are many options in India for passive investments. Compounding can be paired with passive investments to maximize the yield and thus gain more profit. However, thorough research is important to maximize the results while pairing the two.

Passive investing can be a great way of earning that requires minimum effort. So why not get started with passive investing?

Disclaimer: This article is issued in the general public interest and meant for general information purposes only. Readers are advised to exercise their caution and not to rely on the contents of the article as conclusive in nature. Readers should research further or consult an expert in this regard.

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