what-is-passive-investing-and-how-power-of-compounding-helps-passive-investing

What is Passive Investing and How Does Compounding Help?

Passive investing helps build long-term wealth with minimal effort and risk, using strategies like index funds, compounding, and cost-efficient tools.

Written by : Knowledge Centre Team

2025-09-04

1413 Views

8 minutes read

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With automated technology that helps you in creating and implementing strategies for passive earnings, it’s far easier to invest your money at the right time in the right financial instrument. These tools have made it possible for anyone to understand and use investment systems within hours, removing much of the guesswork and manual effort from the process.

Passive earning strategies are designed to work quietly in the background, often requiring minimal, if not zero, effort once set up. They allow your money to grow steadily over time while you focus on other priorities in life.

Let’s dive into the concept of passive investing and see how it works hand in hand with the power of compounding to build long-term wealth.

Key Takeaways

  • Passive investing is a long-term, low-effort strategy where you invest in market indices rather than individual assets.
  • It minimises the need for constant monitoring, research, or active decision-making.
  • Passive investments are more cost-effective, with lower fees and fewer taxes compared to active investments.
  • The power of compounding plays a crucial role in growing wealth over time with passive strategies.
  • Passive investing aligns well with long-term financial goals like retirement or wealth creation.

 

What is Passive Investing?

Predicting market movement and searching for companies that will outperform others is not something smart investors would want to do. If you are employed or self-employed and have a family to look after, investing and growing your wealth should be one part of your life that runs smoothly in the background.

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 maximise returns while minimising 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 to the world.

This strategy has gained popularity worldwide for its simplicity, cost-effectiveness, and ability to deliver consistent returns in the long run.

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Active Vs Passive Investing

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

Active InvestingPassive Investing

Investing in individual companies

Investing in a diversified market instrument


Performance is dependent on each company’s outcome

Performance is dependent on the broader market trend

Costly

Affordable

Needs a portfolio manager

No need for special managers

Frequent buying and selling are 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 on your investment timing. 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.

  • Steady Earning- Investing in passive funds means you’re in it for the long haul. As we all have heard at least once in our lives, ‘slow and steady wins the race.’ It is 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.
  • Fewer Efforts- As one of the most well-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 consistently. 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.
  • Affordable- Active investment requires a manager who will charge loads of money for their services. Passive investing cuts off the middleman and helps you save money. As very little effort is required, any services you take will also cost much less.
  • Lower Risk- Passive investments follow a broader market index. It performs as a group. This diversification ensures that poor performance in one area does not significantly impact your returns individually. Thereby reducing the risk to a great extent..
  • Saving on Capital Gain Tax- Every time you sell an asset to earn a profit, you must pay capital gains tax. While you invest in passive funds, these taxes can be lowered. As you know, passive investments are held for a longer term, so you don’t sell as frequently. This helps you save the tax that active investors pay frequently.

Passive Investing and the 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 ₹1000 in an investment which earns a 5% compounded return per year, it’ll earn ₹50 as interest in the first year. In the second year, even ₹50 will earn interest at 5% thus, you will have ₹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:

  • 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
  • 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.
  • 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.
  • 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.

Apart from passive investing, ULIPs by Canara HSBC Life Insurance offer the following benefits:

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

Conclusion

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 profits 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 maximise the yield and thus gain more profit. However, thorough research is important to maximise 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. The views expressed in this blog are solely those of the writer and do not necessarily reflect the official policy or position of Canara HSBC Life Insurance Company Limited or any affiliated entity. We make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability with respect to the blog or the information, products, services, or related graphics contained in the blog for any purpose. Any reliance you place on such information is therefore strictly at your own risk. You should consult with a qualified professional regarding your specific circumstances before taking any action based on the content provided herein.

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