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How to Gradually Build Wealth Using Passive Investing

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If you have money to invest and you’d like to see it grow, there are several investment strategies you can use, including a passive investing strategy. This strategy involves putting money into an investment vehicle, such as buying a stock, and holding it over many years (as opposed to constantly buying and selling your investments). 

Generally, markets rise over time, and this strategy takes advantage of that steady growth. The goal is to match or slightly exceed market returns in the long haul, not necessarily beat the market. (Retired? Here are some of the 8 best investments for retirees.)

Index funds, mutual funds, and exchange-traded funds are three of the most used passive investment vehicles. Each tries to mirror a particular index, such as the S&P 500 or the Dow Jones Industrial Average.

Passive investment is not for everybody. If you like to be more involved in managing your portfolio and pick individual holdings, a more active investing strategy might be a better approach. Passive investment offers less risk and more diversification, and you are unlikely to score big with this strategy. 

24/7 Wall St. created this list about the passive investment strategy based on a report produced by financial technology company SmartAsset, entitled How a Passive Investing Strategy Works.

The list can be the first step in deciding whether passive investing is for you. If you are unsure, talk to a financial advisor. She or he can clarify your goals and risk tolerance and steer you to the correct investment strategy for you. (Here are 20 best ways to invest $100K.)

Click here to see how to gradually build wealth using passive investing.

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1. What passive investing is

Passive investing or passive management investment strategy, otherwise known as a “buy and hold,” aims to give investors a solid return by holding assets over the long term. As the market rises over time, investors take advantage of those gains. Rather than trying to beat the market by frequent trades in and out of stocks, a passive investor’s goal is to benefit from steady market growth and gradually build wealth with a diversified portfolio. A passive investment is therefore a good blueprint for saving for retirement.


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2. The opposite of active management

An active investment approach is quite the opposite of passive investing. An active investor attempts to time the market and buy certain stocks that would provide above-market returns. In an active management strategy, investors frequently buy and sell stocks.

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3. What about fees

Because stocks and other investments are held for many years, passive investors incur fewer fees. Conversely, investors actively managing a portfolio will be hit with frequent transaction charges.

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4. Index funds

Index funds are a popular investment vehicle in a passive investment plan. An index fund attempts to match the performance of an market index, such as the S&P 500. Because index funds conduct fewer trades, fees are lower. On the other hand, index funds are not designed to outperform the market.


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5. Mutual funds

A mutual fund pools money from shareholders to buy a collection of stocks, bonds, and other investments. With a mutual fund, you are getting a diversified portfolio managed by a professional money manager.

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6. Exchange-traded funds

Exchange-traded funds track major indices, such as the S&P 500, MSCI Indexes, and the Dow Jones Industrial Average. Another difference between ETFs and other funds is that they can be traded like a stock.


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7. It’s about diversification

Instead of riding the hottest stock at any one time, a passive investment strategy rides out the market storms through diversification. Your investments are spread over a number of vehicles that are professionally managed with diversification in mind, so you are not locked into any one asset that may crash and leave you with considerably more loss than you wanted to risk.

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8. The pros of passive investing

Let’s face it: Trading stocks is hard work, and you could end up with significant losses if you pick the wrong ones. In passive management, a professional money manager is doing the work for you. Yet you always know what is in the fund. Another advantage is that your fees will be lower than if you tried to actively manage your portfolio. Also, by holding investments over the long term and with fewer trades, you are unlikely to have a massive capital gains tax at the end of the year.

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9. The cons of passive investing

With a passive investment strategy, you are invested in predetermined investment vehicles. While your rate of return may be slightly higher than the market with this hands-off approach, you probably will not get spectacular gains. Riskier investing strategies, including active management can have higher returns (but also far worse returns).


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10. Passive vs. active management

If you like to be more involved in managing your portfolio and pick individual holdings to aim for higher returns, a passive management strategy may not be the best option for you. Passive investment is for those who want to smooth out the market upheavals with diversification, reaping steady, but not outsized, gains.

Before embarking on either approach, ask yourself how much risk you are willing to take. If you don’t mind shouldering more risk, try your hand at active management. Risk-averse investors would be better served by passive management.

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11. When you should choose passive investing

Which strategy you choose depends on where you are in life and what your objectives are for your money. Want to buy a house in the next three to five years? An active management plan will potentially help with faster gains and get you the funds needed to make that purchase. If you envision a longer-term savings goal such as building a retirement nest egg or a college fund for your toddler, your wiser choice may be a passive investment strategy.

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