Passive investing is an investment approach where you follow a pre-determined strategy, irrespective of what is happening around you.
More often than not, an investor’s decisions are influenced by macro- and micro-economic events. These could be events like the change of a government to a scandal in a popular company or even something like a natural calamity. Your investment decisions can change even because of an event related to your own life–something that could happen in your family or at work.
Altering investments because of personal reasons is understandable. But if you’re a long-term investor, then economy- or market-related occurrences shouldn’t change the way you invest. In other words, your investments should be passive.What's going on in the economy or how the markets are faring in the short-term shouldn't affect the investment decisions of long-term investors. Click To Tweet
Being a passive investor means you continue your investments as per your plan without worrying or bothering about whether the markets went up or down or whether the BJP is in power or the Congress.
Passive investing helps you focus on your investment goals. It helps you stay on track to build wealth over the long-term. And without burning a hole in your pocket.
These are some of the benefits of passive investing–it’s low-cost, low-risk, easy to implement and allows you to earn returns that can be relied on.The major benefits of passive investing are that it's low-cost, low-risk and easy to implement. Click To Tweet
Now that we understand the advantages of following a passive investing strategy, let’s look at the passive investing options available to Indian investors.
Exchange traded funds
An ETF is a type of mutual fund that tracks and follows a specific index or asset. This could be an index like Nifty 50 or an asset like gold. The ETF will closely match the constituents of an index or the price of an asset. Your investments in an ETF will move in the same trajectory as the asset or index it tracks.
ETFs trade on stock exchanges and can be bought and sold during market hours, the same way we would buy and sell stocks of listed companies. As mentioned above, an ETF tracks an index. So, if you invest in a Nifty ETF, you will generate the exact same returns as the Nifty. If Nifty goes up by 10% in a year, your Nifty ETF will also give you 10% returns for the same period. Because ETFs don’t require any active portfolio management, they are low-cost instruments.
These are also mutual funds, similar to ETFs, that track a particular index. The difference between an index fund and an ETF is that the latter trades on stock exchanges and you need a demat account to invest in it. An index fund can be invested in without a demat account through the mutual fund company or a fund distributor. This comes at an added cost though, which is why the expense ratio of an index fund is higher than that of an ETF.
An expense ratio is the fund management fee that an investor pays to the fund company. Expense ratios are calculated annually as a percentage and deducted out of your investments on a daily basis. For example, let’s say Fund A and Fund B both deliver 10% returns in one year. Fund A has an expense ratio of 1% and Fund B’s expense ratio is 2%. In this case, your effective return from Fund A will be 9% and that from Fund B will be 8%. This is how a higher expense ratio can eat into your investment returns.
There are two types of bank deposits that are passive investing options–fixed deposits and recurring deposits. While you can make lump sum investments in fixed deposits, a recurring deposit allows you to invest periodically. Both of these deposits offer a fixed rate of interest and come with a pre-determined lock-in period.
One disadvantage that bank deposits have over other investments is the higher taxation. The interest that you earn from bank deposits is added to your taxable income and taxed as per the tax slab you fall in. Hence, bank deposits make less sense for investors in the higher tax brackets. Not only is the interest lower than what you would earn from market-related instruments, but it is taxed at a higher rate too.
A smallcase is an investment instrument that allows you to passively track and invest in a theme, idea or sector. A smallcase is a portfolio of exchange-traded instruments. There are thematic smallcases centred around ideas like Affordable Housing, GST, Rising Rural Demand, etc that can be used to invest in that theme.
A smallcase is a portfolio of stocks that is built around a specific idea, theme or model. The advantage here is that a smallcase has no expense ratio. You pay a flat fee or charge only when you transact–there are not daily deductions. A smallcase also allows you to customise the portfolio as per your knowledge since you have direct ownership of the shares you buy through it.A smallcase has no expense ratio, which means that you pay a flat fee only when you transact in it. #smallcasesBehtarHai Click To Tweet
These are some of the passive investing options available in India. All of these options have their advantages, but whichever you choose, it’s important to note that passive investing is for the long-term. To get the most out of this investment strategy, you should give it time to work out.