Passive investing means investing in an exchange-traded fund (ETF) or an index fund. By doing so, you can track an index and get returns like those of an index. For instance, by investing in a Nifty 50 index fund or ETF, you can get returns like those of Nifty 50.
Passive investing is an uncool way of making money over the long term. There is no thrill involved in it—just a very long wait. The returns aren’t going to be dazzling either. In India, you would probably get 8–12 per cent per annum, yet passive investing can’t be overlooked.
Passive investing is perhaps the most foolproof way of investing. When you pick individual stocks, you may err, which can hurt your returns. If you invest in an actively managed mutual fund, your fund manager’s bets can go awry. But when you invest in the market or an index, you are sure to get index-like returns. The costs of most index funds/ETFs are also low. This further adds to your return. You don’t have to track an index fund, as you track a stock or an actively managed fund. Finally, you don’t have to suffer the extreme emotions that active investing subjects you to. If you add up all these advantages, passive investing has a strong case.
Of course, you shouldn’t allocate 100% of your portfolio to index funds. In my view, 20% is fine. This part of your portfolio is a no-stress portfolio. You absolutely have to do nothing about it. Over time, if the rest of the determinants remain fine, returns will naturally flow. No sweat. Let the rest 80% part of your portfolio take care of market-beating returns.
Which index funds/ETFs to pick? In India, passive investing is still a new concept. Most ETFs, leaving a few, have low trading volumes. Hence, go for index funds, where the fund house concerned will ensure liquidity. Also, opt for the basic indices, not their derivatives or not the ones which have some engineering done to them. Index funds/ETFs tracking the market, mid-cap and small-cap indices are just fine.
The problem many investors face with passive investing is that they have been injected with the idea of beating the market. For some reason, getting market-like returns has a negative connotation; that shouldn’t be so. Plus they can’t miss all the action that active stock-picking requires. Passive investing is all about patience and inaction; many adrenalin junkies can’t bear it. But this quote from Paul Samuelson, an American economist, sums it up well: “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”