Passive Investing

Shares

Passive Investing – An alternative

So in the post about investment options, I’ve talked about alternatives that everyone has when investing. One of them was P2P investments that I’ve talked about here. Today I will write in more detail about Passive Investing.

What is Passive Investing?

Passive Investing is a strategy where you invest your money in funds with low fees, aiming to maximize your returns over the long run. In this concept, I don’t give money to an investor that will make the decisions for me. I invest money through a fund (ETF) that automatically invests the money accordingly to the investment policy of the fund.

What products are there to execute this strategy?

ETFs. Exchange-Traded Funds. These are funds that basically try to replicate the exact same movements of the market. So for example, if the market – let’s say the S&P500 – goes up by 1% on a particular day, an ETF of S&P500 should go up by 1% minus the cost of the fund. For example, an ETF that follows the S&P500 with a cost of 0.05%/annual, will go up by practically 1%. (The cost is so small that is strongly diluted through the year)

Who should follow this strategy?

I believe that 90% of mankind should – at least consider – use it (but at your own risk!). Especially those who believe that they don’t know how to anticipate the market (I know I don’t…). And studies suggest that the majority of active funds don’t outperform the market.

Why?

Because it’s cheap, easy and simple to follow.

How should I follow this strategy? What allocation?

First thing is building a portfolio and decide the allocation. I personally believe in the KISS method (Keep It Simple Stupid). So I believe in a portfolio of 60% stocks and 40% bonds (60% of my investment money in stocks, 40% of my investment money in bonds). But you have a lot of other options. Here are some.

As a European, the 60% stocks/40% bonds portfolio could easily be executed with only 2 ETFs. For example:
60% – ETF Stocks WORLD (example: iShares Core MSCI World UCITS ETF);
40% – ETF Bonds WORLD (example: db x-trackers Barclays Global Aggregate Bond UCITS ETF 5C (EUR hedged));

You can find “European” ETFs – a lot of options and alternatives – on this website.
US ETFs here.

Why those two funds?

They are both well diversified (each fund has stocks and bonds from all over the world). They are somehow cheap – not as cheap as US ETFs unfortunately. The iShares has a cost of 0,20% and the db x-trackers of 0,30%. So if you compare to active funds…well…there is no comparison. In conclusion they are a lot cheaper.

Example

So for example if someone has 10 000€ (or $ it’s the same in this example), and wants to use the portfolio above, it has to use 6 000€ (60% of 10 000€) to buy shares of the ETF Stocks WORLD, and then has to use 4 000€ (40% of 10 000€) to buy shares of the ETF Bonds WORLD.

Example1

Then after a year for example, if the shares of the ETF Stocks WORLD is valued as 8 000€ and the shares of the ETF Bonds WORLD is valued as 4 500€ I have to rebalance.

Example2

I have to rebalance back to 60% / 40%. So two options: First Option – You could sell some shares of the first ETF, and buy some shares of the second ETF.

Second Option: Save money along the year, and buy shares of the second ETF. So for example, if I saved along the year 900€, I can buy shares of the second ETF, and then I will end up with my initial allocation. Let’s try the second option:

Example3

And that’s it, this portfolio, in this example, is ready for another year.

There are calculations and explanations that are simplified. Only to give a notion of the concept. Comment if you want me to clarify or correct something. 

If you agree/disagree, or wish to add something to this thoughts, please feel free to comment.
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Nothing on this site should ever be considered to be advice, research or an invitation to invest. Please read the disclaimer.

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