There is so much existing material on this topic so I’ll do my best to keep this somewhat entertaining and concise. Plus, I’ll add some links for further reading at the end.
Basically, two types of investing exists, passive and active.
This approach entails index funds or ETFs (exchange traded funds), such as the S&P500 which is an index (collection of stocks) of the 500 largest companies in the US.
Put simply, an index fund/ETF, is a bunch of different stocks (companies) all shoved into one basket (called in index) which trades on the stock market.
Investors can buy shares of the index and subsequently own a tiny piece of each company within that index.
So, if you buy into the S&P500 index/ETF you technically own a minuscule slice of the largest 500 companies in the U.S.
Yes, you read that correctly.
It’s possible for everyday yachties like you or me to invest, with very little money, and own a tiny sliver of Facebook, Microsoft, Paypal, Starbucks and 496 other huge companies.
Look up again, over 500 companies. This, my friends, is diversity and the definition of not putting all your eggs in one basket.
Your investing portfolio does not rely on one stock, it relies on 500. This is just one example, other indexes contain thousands of companies.
This diversity protects you against the downsides of one stock shitting the bed as you have 499 other to pick up the slack.
You nor me nor your financial advisor can consistently pick a winning stock, so why just buy them all?
Even better, the fees are so low (as little as 0.05%) due to the physical absence of an advisor moving your money around for you. It’s all done through complicated algorithms and computers yet research has shown passive investing actually outperforms active investing, strange huh.
Well, not really, here’s why.
Without getting too technical, these funds are programed to mimic the benchmark of the index. This means, if an index fund has been determined to see a 8% return over a year, the very smart computer wizard investing thing works it’s magic to ensure the index you’re invested in (the S&P500 for example) does it’s best to achieve an 8% return as well.
And, most of the time it’s pretty damn close.
It’s similar to a running partner in a marathon or a pace car at racing events.
Passive investing has revolutionized the investing industry allowing everyday people to invest without the need for financial advisors or expert level knowledge.
It’s a set & forget strategy and designed for long term investing (5 years minimum) in an effort to allow compound interest and time to work in your favor. The longer you keep it in, the better.
I have a similar article on the site already which you can read here.
But, I’ll do a quick overview.
Active investing involves hiring a financial professional to manage your money for you.
If you have an investment with a financial service then you most likely have an active financial advisor playing with your cash and trying to predict market movements.
He or she is buying and selling stocks which ultimately costs you more money.
Successful stock picking is very difficult to do consistently and it’s unlikely a financial advisor has the ability to reliably predict the stock market.
Active investing has been shown to underperform against passive investing over the long term which is demonstrated by Warren Buffet demonstrates this here.
In fact, Warren Buffet is such a fan of passive investing that he’s allocated 90% of his fortune to be invested into ETFs upon his death. Read that article here.
Like anything, there are pros and cons to both strategies. Naturally, there are may factors to consider before making your final decision such as:
- Your net worth
- Your future goals
- Your risk tolerance
- Your interest in money
- Your financial education
The outcomes of each style differs greatly from each other so it’s important to undertake further reading and to fully understand which approach is best suited to your situation.
If you’re keen to learn more check out these articles…
- CNBC Article
- A great YouTube video
- Investopedia Article
- Vanguard Article (Vanguard is a large ETF provider)
- Australia Investor Hub
- The Financial Balance Article
Or, just shoot me a message and I can help ya out!