Passive Investing Explained

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Our guide to passive investing explains how you can build a long-term investment portfolio without actively having to decide when and what to invest in. 

What is passive investing?

Passive investing means buying investments that track the overall stock market, rather than actively buying and selling investments and trying to time the market. Passive investing is good for long-term investors and the simplest way to do it is to buy ETFs that track global major indices.

How to build a passive investment portfolio

Investors are increasingly turning away from active management and choosing passive funds instead.

It’s a shrewd move. Because of their lower costs, passive funds will outperform the vast majority of active funds over the long term.

But it’s not as simple as choosing any old index tracker, as ROBIN POWELL explains.

How much money do I need to build a passive investing portfolio?

You don’t have to commit large sums of money. Vanguard, for example, has a minimum investment of £500, and you can invest on a regular basis with as little as £100 per month. Or if you opt for a regular investing (recurring monthly orders) with a platform like Interactive Investor or Hargreaves Lansdown, it is often free.

What are the best markets for passive investing?

Global diversification is the way to go. Most UK investors have a bias towards UK stocks. But the UK accounts for just 3.5% of the world economy. The simplest option is a global index tracker which invests in the shares of companies all over the world.

Should I use a financial adviser?

I would encourage people to use a financial adviser. But it needs to be an adviser who understands the benefits of low-cost indexing. So many don’t.

There are also online investment solutions called robo-advisors or (digital wealth managers), like Nutmeg, Wealthify or Moneyfarm, that passively manage your money for you.

If you choose to act unadvised, don’t take on more risk then you need to, can afford to or are comfortable with.

It’s best in my view to drip feed your money into the markets over a period of time. If you are investing a lump sum, you may want to dampen the risk by allocating a proportion of it to government bonds.

What are the costs involved in passive investing?

Cost isn’t everything, but it’s very important. Generally, the cheaper the fund the better.

Be aware, though, that some of the most popular platforms are expensive. Hargreaves Lansdown’s, for instance, is 45 basis points, or 0.45%. Vanguard’s is a third of the price — 0.15%. But with Vanguard you can only invest in their funds.

Other platforms include AJ Bell (which has a low stocks and shares ISA fee of only 0.25% for ETFs and shares) and Interactive Investor (which charges a flat fee of as low as £4.99 so is great for larger accounts). But compare them carefully. Some will work out cheaper than others, depending largely on how much money you’re investing.

Which funds are best for a passive investment portfolio?

A sensible option is an all-in-one Vanguard LifeStrategy fund. New investors may want to invest in in an 80 or 100% equity fund to start with. More cautious investors could opt for 60:40 fund instead — i.e. 60% equities and 40% bonds.

The fund itself costs 0.22%. If you use the Vanguard platform you’ll get everything — i.e. the platform, the annual management charge and transaction costs for 40 basis points.

Alternatively you could use passively managed ETFs, or exchange traded funds. Some of the cheapest ETFs on the market are provided by Lyxor ETF. Though Lyxor doesn’t have its own platform, most of the big platforms like Hargreaves Lansdown, AJ Bell & Interactive Investor do offer Lyxor funds.

So, for example, you could gain your equity exposure via the Lyxor Core MSCI World ETF, which has a TER, or total expense ratio, of 12 basis points.

A cautious investor may want to balance their portfolio, by investing in the Lyxor Core Global Inflation-linked 1-10y Bond ETF, for which the TER is also 0.12%.

How often should I adjust my passive investment portfolio?

Chopping and changing your portfolio and trying to time the market is a bad idea, and it usually does more harm than good.

So focus on the long term and stick to your chosen strategy through thick. It does makes sense though to rebalance your portfolio every year or so, to restore the original asset allocation.

The key to a successful passive investment strategy is to buy and hold.

Can you use a SIPP for passive investing?

Yes. Most SIPP providers offer access to ETFs, index funds, and other passive investments. These kinds of investments have low fees.

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