Passive investing is a simple yet very powerful financial concept that few people seem to understand or care about. In a nutshell, passive investing is a strategy that aims to maximize returns by assuming long-term positions in the market. While it can indeed improve your net worth, poor execution of passive investing strategies can negatively impact your finances as well.
Asset Types
There are thousands of financial products publicly-traded every day. Some assets that best work with passive investing include real estate, peer-to-peer lending, dividend-paying stocks, and index funds. Each asset class has its own pros and cons that you need to consider, i.e., peer-to-peer lending can yield substantial returns of up to 12 percent but can also involve a higher level of risk.
Time Frame
As mentioned earlier, passive investing is all about minimizing buy and sell orders. Instead, you buy an asset, i.e., stock, currency, or commodity futures, with the intention of holding it for a long period of time. As a result, passive investing is a less risky approach relative to trading or speculation, which attempts to capitalize on short-term price fluctuations in financial markets.
Benefits
Diversification is one of the key benefits of passive investing through indexing. This means buying into an index fund, which is essentially a group of stocks or bonds that is meant to emulate the composition and performance of a particular market benchmark. Indexing effectively distributes the risk so that no single company or bond collapse can have a significant impact on your portfolio.
Another benefit of passive investing is lower transaction fees. Since it’s a buy-and-hold strategy, you minimize buy and sell orders and the corresponding fees charged by your broker. In addition, since there is no meticulous stock selection process involved, oversight costs are much lower. Passive investment funds simply follow a particular market index.
Last but not least, passive investing typically leads to lower capital gains taxes for the fiscal year. For your returns to be taxed as long-term capital gains, it must be held for longer than a year. Currently, the tax rate for long-term capital gains is 15 percent for any amount ranging between $40,401 to $445,850.
Passive income investing can help grow your wealth without the substantial risk and complexities involved. Use a demo account to test out your passive income strategies and to better understand concepts and dynamics at play.