Overview – The Allure of Passive Investing
One of the reasons many people become investors is the idea of making money without having to actively work to earn it. After all, who doesn’t like the thought of earning money while you do something else with your time?
This dream of earning money in the background can, for the most part, be achieved. If their portfolio is large enough, investors can earn enough money from dividends, interest, and rental payments to act as their primary source of income. Even better, they can choose to reinvest these funds to make their portfolio even larger, thereby earning them even more money, ad infinitum.
Many investors try their best to work towards a state of “passive” investing, that is, once they’ve put together an investment portfolio, they can essentially forget about it because it will take care of itself while they sit back and reap the benefits. But is such a thing possible?
What Exactly Is “Passive Investing”?
Though there is no universally agreed-upon definition, passive investing can be thought of as the idea of not needing to actively manage your investments. The phrase “invest and forget” is also closely associated with the idea of passive investing.
The major idea behind passive investing is that the investor does not need to stress over the details of their portfolio such as performance, dividend payouts, reinvestment, and other minutiae because the portfolio essentially does all of that automatically, or has reached a point where these things essentially don’t matter.
In passive investing, the only thing investors will ideally do is collect their payouts and watch their portfolios increase in value. One of the few actions an investor would need to perform is to allocate more funds for investment purposes.
A classic example of passive investing that’s commonly cited is index funds. This is because index funds offer low management fees to investors and require very little maintenance. The only thing an investor needs to do is to put more money into the fund, and after doing that the fund pretty much runs on autopilot.
Because of these things, it’s clear why passive investing is so enticing for many investors and investors-to-be.
While the idea of passive investing is certainly very alluring, it represents a type of ideal state in an investor’s career. It can be achieved, but only to an extent (more on this later). This is because investing will always have some type of work involved, no matter how far along investors are in their careers.
Creating and Maintaining a Portfolio Will Always Involve Work
Before investors can even dream of achieving a state of passive investing, they must first create a world-class portfolio; one that can provide consistent performance, reliable income, and isn’t vulnerable to the whims of volatility. Unsurprisingly, this is much easier said than done, and unless an investor gets extremely lucky, is something that takes years to achieve.
Searching for excellent investment opportunities, performing thorough analysis, creating effective strategies, and constantly managing risk are just some of the many tasks investors will need to perform as they build their portfolios. Weakness or complacency in any of these areas can derail an investor’s efforts to create a superb portfolio.
Even if an investor does everything right, there are still a multitude of factors beyond their control that can affect them such as the movement of global financial markets, macroeconomic conditions, political developments, and bouts of volatility, to name a few.
So, before an investor can even dream of creating a portfolio that they can simply leave on autopilot, there are countless steps they must take before achieving this goal.
Even after investors have achieved a portfolio they’re satisfied with, the work doesn’t end there. Investors must put in the work needed to maintain the portfolios they’ve carefully crafted. Performing routine reviews, creating risk management strategies/procedures, and keeping up with financial news are just some of the tasks that will need to be performed.
Even if investors decide to leave their money in the hands of others such as a mutual fund, they are still responsible for monitoring the fund’s performance and understanding the fund’s investment strategies and philosophies.
So, whether an investor is just starting to create their portfolio or has already created a portfolio they’re happy with, effort will always need to be exerted every step of the way.
The Passive Investing Paradox
As we talked about earlier, the appeal of passive investing is the idea that investors can sit back and leave their portfolios alone while still reaping their benefits, such as steady dividends and capital appreciation.
To achieve this, investors must first create an exceptionally strong portfolio, something that takes a lot of time and effort to achieve. Now, there is no universal definition of what constitutes a “world-class” portfolio, but it is most likely one comprised of various holdings, across different investment instruments (equities, bonds, REITs, commodities, etc), across various countries.
In the preceding section, we discussed how even after an investor has created a portfolio they’re satisfied with, work must still be done to maintain it.
With all of this in mind, we run into the “Passive Investing Paradox”.
That is, to achieve a state of passive investing, investors must first create a world-class portfolio. However, a world-class portfolio will require lots of maintenance work to keep returns satisfactory and risk low, and will only require more maintenance as the portfolio continues to grow, which is bound to happen if investors wish to have a portfolio that can sustain their passive investing.
Some investors who wish to achieve passive investing are fixated on creating a formidable portfolio and leaving it on autopilot someday. However, because a formidable portfolio is most likely very complex, time and effort must be spent to keep it that way.
This is true whether an investor manages their portfolio or if they have someone else manage their investment affairs, but investors who manage their portfolios will experience this more directly.
For investors to sit back and relax, effort must still be expended to maintain that state of relaxation. Such is the implicit irony behind the idea of passive investing.
Passive Investing Is Possible, but Only to a Certain Extent
One of the major misconceptions some investors have about passive investing is that once their portfolios have “made it”, no further work is required on their part. However, as we’ve discussed throughout this article, there will always be work involved when it comes to managing a portfolio when it comes to its creation and maintenance.
With that being said, does this mean passive investing is just a myth? Not necessarily. Passive investing can be achieved, but not in the way that some investors may originally envision.
Although the creation and upkeep of a portfolio will always involve time and effort, this doesn’t mean investors need to be glued to their portfolios all the time.
Instead, investors can work on their portfolios little by little by making small, consistent steps toward creating their desired portfolio. In terms of maintenance, investors can check the status of their portfolios once in a while to ensure everything is in order, whether it’s weekly, monthly, or quarterly.
The time spent in between these routine checks is when investors can sit back and let their portfolios grow, while collecting any dividends/interest their portfolios may yield. This is the “passive” state that many investors seek.
So, passive investing doesn’t mean investors can completely forget about how their portfolios are doing and expect to do that forever. Maintenance will always be required, but this is something that can be done infrequently, which still allows investors to kick back and enjoy the benefits that their portfolios bring.
Wrapping Up
Many investors and investors-to-be dream of achieving a state of passive investing, whereby they don’t need to worry about how their portfolios are doing; all they need to do is sit back, leave their portfolios alone, and enjoy the dividends, interest payments, and capital appreciation that their portfolios will bring.
While this certainly sounds appealing, and understandably so, the reality is that the creation and upkeep of a portfolio will always require investors to put in the work, no matter where they may be in their careers. In addition, the larger and more complex an investor’s portfolio becomes, the more maintenance is needed to ensure everything is in order.
For investors to maintain a state of passive investing, they must put in more work to ensure their portfolios can sustain such a lifestyle – such is the irony that underpins the idea of passive investing.
Passive investing can, for the most part, be achieved. Investors will need to check on their portfolios once in a while to ensure everything is in order, but most of the time they can still sit back and leave their portfolios alone all while reaping whatever benefits they may yield.
