The Rise of Passive Investing: ETFs and Index Funds

The stock market is a dynamic space where trends gain and lose popularity over time. In recent years, one such style of investing that has been gaining favour with investors is passive investing. Considered to be suitable for beginners and seasoned investors alike, passive investing strategies allow you to invest in the markets in a cost-effective manner.

Let’s take a closer look at various passive investment options like ETFs and index funds and get to know the benefits of passive investing.

What is Passive Investing and How Does it Work? 

Typically, in an active investment scheme, a fund manager takes on the responsibility of selecting stocks and assets for the fund’s portfolio. The fund manager is also responsible for deciding how much to invest in different assets, when to rebalance the portfolio and when to exit a position.

Passive investing, on the other hand, does not require any such active intervention. Instead, it involves tracking the performance of a benchmark like a broad market index. The portfolio in a passive investment vehicle is aligned with the benchmark index. So, rather than trying to beat the market average, passive investing attempts to match the market returns instead.

Passive Investment Options: ETFs and Index Funds 

Passive investing works for different asset classes. In the case of equity investments, exchange traded funds (ETFs) and index funds are among the most popular options. Let’s check out the details of these two passive investment instruments.

Index Funds

Index funds are essentially mutual funds that replicate a specific index. The benchmark index could be a broad market index like the Nifty 50 or the Sensex, or a sectoral index that consists of stocks belonging to specific market segments. It could also be a strategy index, a thematic index or an index based on market capitalisation. In an index fund, the need to actively manage the funds is eliminated, since the portfolio is designed to track the underlying index.

The fund manager’s only responsibility is to ensure that the stock selection for the portfolio of an index fund replicates the benchmark. Thereafter, as the benchmark index changes in composition, the index fund’s portfolio needs to be rebalanced to reflect this change.

Exchange Traded Funds (ETFs)

An ETF is a type of fund that is also passively managed. It can track an index, a commodity or even an index fund. The defining feature of ETFs is that they can be freely bought and sold on stock exchanges, thus giving them the name ‘exchange traded funds.’

Since ETFs also track a benchmark, they do not require active management and monitoring. The fund manager only needs to make minor adjustments periodically to ensure that the ETF portfolio remains aligned with the benchmark.

The Rising Popularity of Passive Investing 

As of March 2023, the AUM of index funds recorded a massive year-on-year growth of 144%. The AUM of passive funds, in general, rose by 34% in FY23. Clearly, investors are starting to take note of the various benefits of passive investing, leading to their rising popularity.

Here is an overview of the primary advantages of passive investing via ETFs and index funds.

Lower fees that make investing more affordable

Lower overall expense ratio

Better suited for investors with a long-term investment outlook

No need to time the market or constantly track the investment

Conclusion

Passive investing has emerged as a viable investment strategy that aims to track and mimic the performance of a benchmark rather than beat it. With passive investment vehicles like ETFs and index funds becoming popular, you can now invest in a readymade stock portfolio at lower fees.