Passive investing refers to the strategy of buying funds that mirror the holdings of market benchmark indices such as the S&P 500, and holding the funds for a long time. 

The objective is to match the performance of the indices, rather than to beat them. Such funds can be bought through your brokerage account, mutual fund companies, or robo-advisors.

In contrast to passive investing, active investing involves the short-term trading of securities based on extensive research and analysis by a portfolio manager to try to beat the market. 

What is an index fund?

An index fund is designed to be a passive investment that mimics the performance and composition of a financial market index. It can come in the form of a mutual fund — known also as a unit trust — or an exchange-traded fund (ETF).

A vast array of indexed mutual funds and ETFs track the broad market as well as narrower sectors such as small-cap stocks or stocks in specific industries. 

The first index fund was created by John ("Jack") Bogle, the founder of asset management firm Vanguard. He revolutionised investing with his philosophy and belief that to succeed in investing, investors should buy exposure to the entire market, rather than stock pick. That's how the trillion-dollar passive investing industry was born.

The Vanguard 500 Index Fund has been tracking the S&P 500 consistently. As of March 2022, Vanguard’s Admiral Shares posted an average annual return of 7.87%, close to the S&P 500’s 7.89%. 

Unit trusts and ETFs are very similar in the way they offer diversification of stocks and can both suit the long-term investor.

The main difference between them lies in how investors buy and sell units or shares. ETFs can often be traded like a stock throughout the day on a stock exchange. On the other hand, unit trusts trade at the net asset value of the fund, which is based on the day’s market closing price, and can appeal more to long-term investors who do not need intraday liquidity.

In some instances, unit trusts may be more expensive than ETFs — but this is not always the case. There are in fact lower-cost share classes for unit trusts, with management fees that are in line with or below ETFs for similar or better-implemented exposure. It is important to understand the fees involved for ETFs and unit trusts. Endowus has also launched the lowest cost passive index fund series in Singapore.

Another big misconception is that all ETFs are passively tracking the markets while all mutual funds are actively managed. The truth is, there are numerous ETFs that are not indexed or traded actively, and many also track different sub-sectors of a single country’s market. At the same time, there are also unit trusts that are passive indexed funds.

Why passive investing should form a core part of your portfolio

You might ask: “Why should I invest at all?” After all, saving your money essentially guarantees that you will not make any losses, whereas investing comes with risks.

Indeed, savings can provide a safety net when it comes to unexpected expenses, and they also lay the foundation for building your wealth. But by itself, saving is not sufficient to manage inflationary pressures — your money, sitting in a bank account drawing low interest rates, is unlikely to grow at the same pace as inflation, which hurts the purchasing power of that cash.

That is where investing comes in. Investing can grow your wealth by putting your money to work today with the expectation that it will subsequently provide a rate of return that makes the delayed gratification worthwhile.

Passive investing in particular also lowers your risk as it spreads your investments across a mix of asset classes, industries, and geographies, instead of an individual stock.

Lately, many investors have preferred passive investing to active investing. This comes as active mutual fund managers’ returns have consistently trailed those of passive funds over a recent 10-year period.

Moreover, passive funds tend to charge lower fees than actively managed funds. This difference in fees can have a significant effect on investors’ returns when compounded over longer time frames.

You can apply a passive investment strategy on your core portfolio — such as your retirement fund — to lock in steady returns in the long run, and then also explore market trends and themes with a smaller portfolio allocation to enhance your returns. Learn more about core-satellite strategies here.

Here are some ways people earn additional income from passive investing in Singapore.

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Next on the Endowus Fin.Lit Academy

Read the next article in the curriculum: Building a classic 60/40 investment portfolio