Passive investing is an investment strategy which is almost the same as ‘Buy it and forget it’. Here the investor or the mutual fund manager selects the stocks that have excellent growth prospects over the long term, invests money into these stocks and just forget about them for years, even for a decade or two.
Needless to say, passive investing is a long term strategy aimed at capital growth, so this strategy is not for those looking for regular income or capital appreciation over the short term. Of course, such passive investment may reward the investor in the form of dividend every year, but getting dividend income is not the objective of such an investment.
So how does an investor choose stocks or mutual fund scheme for such passive investment? An investor wanting to invest in stocks over the long term can simply go for the industry leaders having sizeable market share, excellent management bandwidth and commendable track record of financial performance. Such stocks can belong to diverse industries, sectors and segments of the economy. If the investor finds the task of picking up the right stocks for the portfolio too daunting, he can choose to invest in an index fund. Index funds are usually managed passively as the stocks to invest in and the weightage to be given to each of the index stocks are both determined by the composition of the index.
The fund manager with a mandate to manage the portfolio in a passive manner usually chooses to invest the corpus of the fund in the stocks comprising the index. This way, the index fund mimics the performance of the index so that if the index moves up, the index fund moves up, and if the index goes down, the index fund too goes down.
In the case of index fund, the fund manager does not have much to do, except when there is any change in the stocks comprising the index. A stock in an index can be moved out and a new stock included in its place in the index over a period of time, but such changes happen only occasionally. But when such a change takes place, the fund manager has to make necessary changes in the fund’s portfolio of stocks to keep the index fund’s composition in line with that of the index.