The growth of passive investing has accelerated with the expansion of ETF investments. Here’s more on that trend, plus a look at other passive investments you should know about

Passive management is also known as indexing. That’s in contrast to active management.

The growth of passive investing for the most part comes from ETFs, which are essentially highly efficient mutual funds with low fees. That lets investors avoid the higher fees that accompany active management. “Traditional ETFs” passively follow the lead of whoever sponsors the index.

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We think that investors are gaining from the growth of passive investing…especially with lower costs

Passive fund management for ETFs involves investing to mirror the holdings and performance of a specific stock-market index.

Sponsors of passive stock indexes such as Standard & Poor’s do from time to time change the stocks that make up the index, and they do tinker with the rules for calculating the index. However, these changes are kept to a minimum. ETFs then adjust their portfolio holdings to reflect these changes, without considering any impact the changes may have on the performance of the ETF portfolio.

This “traditional,” passive style also keeps turnover very low, and that in turn keeps trading costs for your ETF investments down. All in all, we think you should stick with “traditional” ETFs.

Passive fund management stands in contrast to the “active” management that conventional mutual funds provide at a much higher cost. Active management is when a fund manager picks stocks on an ongoing basis, rather than aiming to match benchmark indexes. To do this, they use research, forecasts, experience, judgment and so on to make investing decisions aimed at outperforming the investment benchmarks.

Active portfolio management for individual investment accounts also bases stock selections on the client’s investment objectives, age and personal circumstances.

Conventional mutual funds and some “new” ETFs are examples of investments that use active portfolio management. As mentioned, active management comes at higher costs than investments like passive ETFs.

Owning investment real estate is far from passive investing

In reality, owning investment real estate doesn’t quite fit within any asset allocation pigeonholes. It’s more of a small business than a passive investment like stocks and bonds. (I call them “passive” in this instance because you don’t need and aren’t expected to help manage the companies you are investing in. Of course, you do have to manage your investment portfolio, or hire somebody to do it for you.)

Real estate investors have to make periodic business decisions, such as whether to replace or repair faulty furnaces, leaky roofs and so on. They need to advertise for tenants, winnow out bad prospects from good ones, negotiate rents, keep the plumbing in good repair, decide when to paint and what colours, and so on.

Many real-estate investors have had good results in the past few decades. Growing population and rising affluence deserve a lot of credit for these gains, because they’ve helped push up virtually all real-estate prices. However, investors who achieve capital gains from investing in real estate also owe some of their success to two additional factors:

• The unpaid and often uncounted hours of labour (sometimes referred to as “sweat equity”) they devoted to their properties, and
• The fact that they employed leverage—borrowed money—to invest. Leverage magnifies the ultimate return, but at a cost of magnifying your risk.

If we have to force real estate investments into one of our five main economic sectors, Manufacturing & Industry would be the best choice. A strip mall or five-plex may not superficially seem to have much in common with IBM or Ford Motor Company, but there are similarities.

Use our three-part Successful Investor approach for portfolio success

1. Invest mainly in well-established, dividend-paying companies;
2. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; the Consumer sector; Finance; Utilities);
3. Downplay or avoid stocks in the broker/media limelight.

What forms of passive investing do you focus on?

Do you feel like passive investing offers the returns you want or do you prefer active management ETFs, for example?