Glossary
Passive investing
Owning a whole market or index through low-cost funds and holding it, instead of picking stocks or timing trades to beat it.
On this page
Passive investing is a strategy of buying the whole market, or a broad slice of it, and holding it for the long run rather than trying to beat it. In practice that usually means owning an Index fund or index Exchange-traded fund (ETF) that tracks a benchmark such as the S&P 500. The goal is to earn the market's return minus a very small fee, instead of paying more in the hope of outperforming.
How it works
A passive fund follows rules set by an index provider. When the index adds or drops a company, or changes weights, the fund trades to match; otherwise it sits still. There is no research team picking stocks, which keeps costs and turnover low.
The case for it rests on arithmetic. Before costs, the average dollar invested actively must earn the market return, because together active and passive investors own the whole market. After costs, the average active dollar must therefore trail the average passive dollar by the difference in fees and trading costs.
Common misconceptions
- Passive is not risk-free. An S&P 500 fund fell about as much as the index did in 2008 and in early 2020. You own the market's losses too.
- Choosing an index is an active decision. Picking US large caps over global stocks, or adding a Sector fund, is a bet. So is deciding when to stop buying.
- Passive does not mean never touching the portfolio. Most passive investors still rebalance back to a target mix of stocks and bonds.