The first thing that comes to mind when people hear the phrase “passive investing” is probably real estate. Yet anyone who has ever owned a rental home or apartment knows there’s no such thing. You have to collect rent, repair the property, pay taxes and so on. It’s work.
It’s common, then, to think that it’s really important to be hands-on with retirement investing. After all, if you’re not making decisions, who is?
Yet research shows that the more decisions we try to make about our investments in the markets, the more likely we are to introduce biases. Those biases, many of them completely unknown to us, lead to costly mistakes.
We buy things too late and pay high prices. We sell them too late and cement losses. We buy investments on a whim, a tip, a bit of news that is out of date and perhaps exaggerated.
Or we go the opposite route, investing far too conservatively, even sitting in cash for long periods. It might feel bad to watch your previous investments decline in face value, but it’s far worse to give up quarter after quarter of gains forever while inflation eats away at your cash.
So what do we mean by “passive” investing anyway? Here’s what passive investing really is (and is not):
1. Owning markets (not stocks)
The passive investor is unconcerned with the relative performance of one company over another in terms of its stock price. If it’s a well-capitalized company and represented in a broad index, the key is to own it and all of its peers. No stock picking.
2. Own asset classes (not just stocks)
A lot of people fixate on the stock market, but a powerful portfolio will contain public and private bonds, real estate, foreign equities and foreign debt. While comparing your gains to the S&P 500 or the Dow is a good yardstick, it really isn’t the same thing as owning only stocks, even over the long term.
3. Rebalancing (not trading)
Buy low and sell high, as the trading dictum goes. Yet that’s nearly impossible to do consistently. Often, the big wins get canceled out by losses, leaving the small investor — and eight out of 10 large investors — behind the market return average. Instead, sell gainers as they rise and use the money to buy back into decliners. Just rebalancing can help you get an extra 1.5% over the stock market alone.
4. Avoiding emotions (not risk)
Risk is a funny word. It implies danger, except in investing circles, where it can imply reward. The key is to take the right kind of risk (owning stocks, for instance) while avoiding the wrong kind (panicking and selling out when markets lose ground).
5. Compounding (not cashing out)
Do you need to sell your investments at the “right moment?” Not if you rebalance steadily and shift your portfolio slowly toward more conservative holdings as you age. “Going to cash” in the markets is not good timing. It’s a form of panic and a sign you shouldn’t be investing at all.
You can learn to be a successful passive investor. In fact, a disciplined passive investor cannot help but be successful, given the right frame of mind and reasonable goals. Retiring on time is a very reasonable goal, and it’s one you can achieve.