What is passive investing

Back to Money advice
29 June 2018
Investing can be compared to baking a cake.
And with passive investing, investors can have their cake and eat it too!

To bake a cake, you follow a recipe that shows the ingredients and their quantities, as well as how long the cake should bake in the oven.

When it comes to passive investing, the ingredients are the individual stocks or indices, and the quantity is the weight in those different stocks or indices, according to Nerina Visser, ETF strategist and head of the South African CFA® society.

OUTvest designed its unit trusts using a passive investment strategy, which follows a recipe, much like a baker would to bake a cake.

Just as everyone has a taste for certain cakes and there are types of cakes for every occasion, there are some investments more suited to certain people and their type circumstances.

With OUTvest as the baker, you as an investor get the perfect recipe for the right cake for your circumstances – all that is required now is to follow the recipe’s baking time.

When the baker has added all the ingredients together, the cake is placed in an oven and only taken out after a certain amount of time as specified in the recipe. When it comes to investments the time (known as your time-horizon) is also important, says Visser.

Your time-horizon is how long you would like to invest for or how long you must invest to achieve a financial goal.

“When baking a cake, you leave it in the oven for a specified time, say an hour, and you don’t open the oven door after 10 minutes. You can look through the oven’s window, but if you take it out early the cake won’t rise properly and would probably be a flop.

“The same goes for your investments. If you have specified that you want to invest for say 10 years, don’t open the oven door after six or twelve months and take your investment out.

Like the cake, your investment won’t be what it could or should be when you take it out early.”

Well, it can be if you have a good recipe, the right ingredients and patience. 

But what exactly is passive investing?

Passive investing, or index-based investing, occurs through investments based on products linked to indices, such as Exchange Traded Funds (ETF’s), according to S&P Dow Jones Indices. (Link: https://africa.spindices.com/index-literacy/leveling-the-playing-field)

Index-based investing is not, as the term may imply, investing directly in an index.

According to S&P Dow Jones that is because an index isn’t an investment, but a measure of securities (or shares) or other assets in a specific market. Indices can and do serve as the basis for investment products, such as ETFs, or unit trusts with index-trackers as the building blocks.

The index to which an index product is linked determines that product’s portfolio.

For example, the CoreShares OUTModerate Fund tracks the CoreShares OUTmoderate index, and the fund holds the shares in that index and seeks to match its performance.

“That’s the fundamental difference between index-based investing and active management. Using an active approach, managers subjectively select securities in an attempt to beat their benchmark indices,” according to S&P Dow Jones.

Passive management or passive investing is an investment strategy in which the fund manager makes very few portfolio decisions to minimise transaction costs, including the incidence of capital gains tax, says Visser.

Using Index funds is the most popular method of executing the strategy. Index funds mimic the performance of an externally specified index. With passive investing your investment tracks the performance of the underlying index and therefore you can expect a return in-line with the return of the index.

Passive investing has numerous benefits, which include diversification, transparency, market return and cost efficiency.

Even “passive” investing is active

The concept of “passive” investing is generally interpreted as “doing nothing”, according to Visser.

“And that’s what people don’t like, people do not feel comfortable not doing anything.”

All investing is active, even “passive” investing, it’s only the level of activity that varies, says Visser.

“And the activity is what costs money. Costs and fees goes hand in hand with the level of activity, the more activity the higher the costs and the more it takes away from the [investment’s] performance.”

OUTvest uses a passive investment strategy and the building blocks of the unit trusts offered by OUTvest are index trackers. With S&P Dow Jones Indices, the world's largest index provider, and CoreShares, a leading South African passive investment manager, the OUT-indices and funds were developed.

Each index serves as a set of rules that governs how each unit trust invests. The result is a series of four transparent unit trusts that work together to ensure that you will always be in a suitable investment fund for your goal.

The bakers at OUTvest has prepared the cake and each ingredient is a passive index-tracker and each ingredient has been assigned the correct weights needed in the recipe.

The bakers select the necessary ingredients (the index and asset exposure), and the quantities (the weight of the exposure), to help the investor reach their goals.

“As an investor, you want to be exposed to right asset classes. Index tracking, or passive investing, is a way of getting exposure to the right asset classes,” says Visser.

When you are invested in the right fund, your investment will most likely help you reach your financial goals by giving returns that beat inflation.

Check out our App, call one of our financial advisors and start building your financial cake today.

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