Passive

Lesson

Passive investing is an investment strategy that aims to maximize returns over the long run by minimizing the amount of buying and selling. This approach is based on the belief that the market will generally produce positive returns over time and that active management is unlikely to outperform the market consistently. Passive investors typically invest in index funds or exchange-traded funds (ETFs) that track a specific market index.

Practice Question #1

Which of the following best describes passive investing?

A) Frequent buying and selling to outperform the market

B) Adjusting asset allocation based on market conditions

C) Minimizing trading and tracking a market index

D) Selecting individual securities based on expected performance

Select an option above to see an explanation here.

A) Frequent buying and selling to outperform the market is an active investing strategy. B) Adjusting asset allocation based on market conditions is a tactical asset allocation strategy. C) Minimizing trading and tracking a market index is the core principle of passive investing. D) Selecting individual securities based on expected performance is a security selection strategy.

Terms

Passive investing:: An investment strategy that seeks to minimize trading and maximize long-term returns by tracking a market index.
Index fund:: A type of mutual fund or ETF designed to track the performance of a specific market index.

Practice Question #2

Which type of investment fund is commonly used in passive investing?

A) Hedge fund

B) Actively managed mutual fund

C) Index fund

D) Closed-end fund

Select an option above to see an explanation here.

A) Hedge funds are typically actively managed and not associated with passive investing. B) Actively managed mutual funds are not aligned with passive investing principles. C) Index funds are designed to track the performance of a specific market index, making them a popular choice for passive investors. D) Closed-end funds can be actively or passively managed, but they are not as commonly used in passive investing as index funds.

Do Not Confuse With

Market timing:: An active investment strategy that involves buying and selling securities based on predictions of market movements.
Tactical asset allocation:: An active investment strategy that involves adjusting the allocation of assets in a portfolio based on market conditions and forecasts.
Security selection:: An active investment strategy that involves choosing individual securities based on their expected performance.
Active investing:: An investment strategy that involves frequent buying and selling to outperform the market.

Practice Question #3

What is the primary goal of passive investing?

A) To consistently outperform the market

B) To minimize trading and maximize long-term returns

C) To predict market movements and adjust asset allocation accordingly

D) To select individual securities based on their expected performance

Select an option above to see an explanation here.

A) Consistently outperforming the market is a goal of active investing, not passive investing. B) Minimizing trading and maximizing long-term returns is the primary goal of passive investing. C) Predicting market movements and adjusting asset allocation accordingly is a market timing strategy. D) Selecting individual securities based on their expected performance is a security selection strategy.

Historical Example

In the 1970s, the introduction of index funds revolutionized the investment industry by providing investors with a low-cost, passive investment option. This innovation was based on research showing that most actively managed funds failed to consistently outperform the market, leading many investors to embrace passive investing as a more efficient way to achieve long-term returns.