Question

Discuss the approaches currently used by retail investors to passively invest in equities markets, and consider how this may have changed over the past twenty years

Answer 1

Passive investing has been one of the segments in equity markets investing that has seen rapid growth in last few decades. Also known as 'Buy and hold' strategy, it is different from active investing in the sense that investors don't actively buy and sell on a regular basis or switch between various stocks on a regular basis. Instead, passive investing is based on investing in a well diversified portfolio of stocks with a long-term view and than waiting patiently for the portfolio to follow long-term underlying business and economic trends of the markets.

Passive investing grew in stature with a realisation among retail investors that it's very hard to outperform the markets with active buying and selling, and that long-term investing in a well diversified portfolio, without worrying about the short-term fluctuations, is the most likely way to gain from the long-term economic trends which are more stable and certain.

Approaches currently used by retail investors for passive investing:

While the traditional passive investing involved investing in a well diversified portfolio of stocks with long-term view so that the overall performance of market can be replicated without incurring management fee, the last few decades have seen the game completely changed with the introduction of Index mutual funds and ETFs.

Index funds and ETFs have brought in significant changes in the game of passive investing and have offered retail investors new tools to use. Let's take a look at these modern tools for passive investing:

• Index funds are mutual funds created to replicate the performance of an underlying index such as Nifty, S&P500, etc. These funds are not managed actively by fund managers, rather their composition simply tracks the composition of underlying index so that their performance mirrors the performance of the underlying index. This also means that the retail investors don't have to pay hefty fund management fee.
• Exchange traded funds (ETFs) is like index funds in their nature of tracking an underlying index but they have made the process of passive investing even simpler by allowing investors to trade these funds on stock exchanges just like stocks

Index funds already account for a big share of the total investment management business in the US and globally, and have become one of the most favourite tools for retail investors to invest their money in equity markets