View source for Passive Investing

== Introduction ==
Passive investing is an investment strategy that aims to maximize returns over the long run by minimizing buying and selling. This approach involves creating a well-diversified portfolio that mirrors a market index, such as the [[S&P 500]], and holding it over a long period of time. Unlike active investing, which seeks to outperform the market through stock picking and market timing, passive investing focuses on achieving market-average returns with lower costs and reduced risk.

== Historical Background ==
The concept of passive investing gained prominence in the 1970s, largely due to the work of economist [[Eugene Fama]] and his Efficient Market Hypothesis (EMH). Fama's research suggested that it is difficult to consistently outperform the market because stock prices already reflect all available information. This laid the groundwork for the development of index funds, which are the primary vehicles for passive investing.

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== Key Principles ==
=== Efficient Market Hypothesis (EMH) ===
The Efficient Market Hypothesis posits that financial markets are "informationally efficient," meaning that asset prices reflect all available information at any given time. As a result, it is nearly impossible for investors to consistently achieve higher returns than the overall market through active management. This hypothesis underpins the rationale for passive investing.

=== Diversification ===
Diversification is a risk management strategy that involves spreading investments across various asset classes, sectors, and geographies to reduce risk. By holding a diversified portfolio, passive investors can mitigate the impact of poor performance in any single investment.

=== Low Costs ===
One of the main advantages of passive investing is its cost efficiency. Passive funds typically have lower [[expense ratios]] compared to actively managed funds because they require less research, trading, and management. Lower costs can significantly enhance net returns over the long term.

== Investment Vehicles ==
=== Index Funds ===
Index funds are mutual funds or [[exchange-traded funds (ETFs)]] designed to replicate the performance of a specific market index. They provide broad market exposure, low operating expenses, and low portfolio turnover. Popular index funds include those tracking the S&P 500, the [[NASDAQ-100]], and the [[Russell 2000]].

=== Exchange-Traded Funds (ETFs) ===
ETFs are similar to index funds but trade like stocks on an exchange. They offer the flexibility of intraday trading and typically have lower expense ratios. ETFs can track a wide range of indices, including those focused on specific sectors, commodities, or international markets.

== Advantages of Passive Investing ==
=== Consistent Performance ===
Passive investing aims to match market performance rather than beat it. Over the long term, this approach has proven to be effective, as the majority of actively managed funds fail to outperform their benchmarks.

=== Lower Costs ===
The lower expense ratios of passive funds mean that investors keep more of their returns. This cost advantage is particularly significant over long investment horizons.

=== Simplicity ===
Passive investing is straightforward and requires less time and effort compared to active investing. Investors do not need to constantly monitor the market or make frequent trading decisions.

=== Tax Efficiency ===
Passive funds generally have lower turnover rates, resulting in fewer taxable events. This can lead to greater tax efficiency and higher after-tax returns.

== Criticisms and Limitations ==
=== Market Inefficiencies ===
Critics argue that passive investing assumes markets are always efficient, which may not be the case. Market inefficiencies can create opportunities for active managers to outperform.

=== Lack of Flexibility ===
Passive investors are committed to their chosen indices and cannot easily adjust their portfolios in response to market changes or economic conditions. This lack of flexibility can be a disadvantage during periods of market volatility.

=== Potential for Lower Returns ===
While passive investing aims to achieve market-average returns, it does not offer the potential for higher returns that successful active management can provide. Investors seeking to outperform the market may find passive investing less appealing.

== Conclusion ==
Passive investing is a widely adopted strategy that offers a low-cost, low-risk approach to achieving long-term financial goals. By adhering to the principles of diversification, cost efficiency, and market efficiency, passive investors can build robust portfolios that mirror the performance of market indices. While it may not offer the potential for outsized gains, passive investing provides a reliable and straightforward path to wealth accumulation.

== See Also ==
* [[Efficient Market Hypothesis]]
* [[Index Fund]]
* [[Exchange-Traded Fund]]
* [[S&P 500]]
* [[NASDAQ-100]]
* [[Russell 2000]]

[[Category:Investment]]
[[Category:Finance]]
[[Category:Economics]]