A buy-and-hold portfolio strategy
Anyone who looks at investing to build wealth needs to diversify his/her portfolio. This is done to spread risks across various asset classes, as different asset classes behave differently over different economic periods. For example: In 2020, when the pandemic struck, there was widespread fear and uncertainty, the stock markets around the globe tanked. But gold, which is considered a safe haven, moved up 24%.
An investment portfolio can be diversified by holding distinct assets like equities, debt, gold, real estate, etc.
What is Passive Investing?
Passive investing is a method of investing that is gaining more ground each day. This form of investing, also known as a buy-and-hold strategy, aims at replicating the index in composition and returns. Active investing looks at beating the benchmark/index through active stock/asset picking.
The most popular instruments used with passive investing are Index Funds and ETFs. Index Funds are the normal mutual funds with portfolio same as that of the index. ETFs are Exchange-Traded Funds traded over the stock market but they replicate their benchmark portfolio.
There is a tremendous cost advantage with passive investing as they come with a lower expense ratio, which, when compounded over the long term, ensures better returns for the investor.
How to diversify the portfolio with passive investing?
The beauty of passive investing is that, besides cost benefits, it can replace all the components of the portfolio easily and ensure effective diversification. Various passive investment products can help diversify the portfolio.
Passive funds as a replacement for core portfolio
An equity investor could invest in funds/stocks of different market capitalization like large-cap, mid-cap, and small-cap.Market capitalisation also represents the growth stage of companies with larger cap being better established and vice versa. Spreading investments across various market capitalisation is a way of diversification within equities.
Index funds/ETFs that mirror the Sensex/Nifty 50 are an excellent way to replace the large-cap funds/stocks as the stocks on the index are some of the best-performing stocks spread across sectors of the economy.
Passive funds for satellite portfolio
Investing follows a core and satellite approach, where the core portfolio or a majority of the portfolio is invested in large-cap. Other market cap offerings like the mid-cap, small-cap, and other sectoral themes make up the satellite portfolio.
Index funds & ETFs mirroring the mainstream indices of Sensex and Nifty are popular but there are index funds & ETFs that mirror other Nifty Indices like the Nifty Midcap 150, Nifty Small Cap 250, or even the Nifty 500. These Index funds/ETFs can form an excellent proxy for Midcap & Small-cap funds/stocks.
There are index funds/ETFs for thematic indices like banking, healthcare, consumption, infrastructure, or even ESG. One can make use of these for investing in the satellite portfolio.
International investing has become a must as a means of diversification over recent times. Index Funds or ETFs allows to invest in S&P 500, Nasdaq 100, or the Hang Seng Index.
Other passive investment instruments like Fund of Funds (Funds that invest in other mutual funds/ETFs) or Smart Beta funds (Index funds that meet certain criteria like low volatility, value, etc) are also available for diversifying the portfolio. However, the expense ratio of these kinds of specialised instruments may not be as low as vanilla passive products.
Passive offerings for the debt component of the portfolio
Debt or fixed income is also an essential part of the portfolio to manage risks. There are passive fund offerings in the form of Index Funds/ETFs that invest in Gilt funds, Bharat Bond ETFs or Liquid BeES ETFs that invest in the overnight money market. One can choose from these to diversify.
Passive investing for other asset classes
Gold is a highly preferred investment with Indians. If physical gold isn’t needed, investment through Gold ETFs can help in investing in gold linked to domestic gold prices at lower costs and lower risk.
So, it is possible to diversify the portfolio with a wide range of passive investing products that come with lower costs. Go passive!
[author title=”Abhilash Joseph, Business Head, Finity” image=”http://”][/author]