In the previous article, we presented in some detail the advantages and disadvantages of an active management strategy. Here we present the passive strategy.
Passive management is a strategy focused on long-term gains. It requires less involvement in the day-to-day management of your investments, where the target returns are usually similar to the performance of an index, usually the S&P500.
Many passive investors use ETFs that track a particular index as a passive investment vehicle. This can be described as buy and hold management, i.e. buying and holding assets for long periods of time, requiring only some knowledge and patience on the part of the investor.
- Costs – Since the amount of transactions is much smaller than in active management, it is possible to reduce a good part of the operational costs.
- Taxes – This management involves keeping the assets for several years. So, since the assets are not liquidated or sold, there is no obligation to pay taxes. This can be a very important point, instead of wasting part of the profit on taxes, by keeping your investments the profit is added to your positions (doubt this sentence)
- Time/Knowledge – As this strategy focuses on the reproduction of indexes, (in the case of private/small investors) through ETF’s it ends up requiring little time and knowledge. Compared to the knowledge required for active management, a basic knowledge of market terms and functioning is enough to get good returns over time efficiently.
- Lower potential returns – While active management is constantly looking for the best gains to be able to outperform benchmarks such as the S&P500, passive management is somewhat more limited. Because a passive management strategy is used it replicates the underlying indexes and their returns, so you will only get above-average returns if the indexes themselves do as well.
- Identical – Most ETFs that replicate indexes are basically identical, so for those looking for a more personalized investment that fits their needs, this type of management will not be the best choice.
- Unidirectional – Almost no ETFs hedge risk, meaning that they only profit when the market rises. It means that investors, in case they experience a fall in the financial markets, have to wait for a market recovery to realize profits.
This management will most likely be suitable for most investors. It requires relatively little time and knowledge, making it ideal for beginners, or part-time investors who are looking for extra income for the future.
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