Passive investing, also known as buy-and-hold investing, is a widely popular investment approach. As per this strategy, one invests in stocks and other securities with the intention of holding onto them for an extended span of time, no matter the changes in the stock market. As Kavan Choksi mentions, passive investors ignore day-to-day market movements and allow the investment to perform over the long term.
Kavan Choksi marks a few key benefits of passive investing
Volatility in the United States stock market can be intimidating. It even causes experienced buy-and-hold investors to often second guess their strategy. History does show that the market is ideally able to recover from declines over time and still provide investors with a positive return on long-term investments. However, one must also understand that past performances are essentially not a guarantee of future returns.
A passive or buy-and-hold strategy can help investors to avoid missing out on the biggest days of the market. One of the hardest parts of having to determine when to be in or out of the market is that missing a few important days or weeks of a five- or 10-year cycle may have a huge impact on the returns. Historically, a large share of the gains and losses in the stock market take place just a few days of any given year. As the patterns of returns are not predictable on a monthly basis, a consistent investment can add to the bottom line.
A buy-and-hold strategy can also help investors to take advantage of compound interest. The inflation-adjusted annual average return on investment of S&P 500 is about 7%. This basically means that on average the value of the index is 7% higher at the end of the year than it was at the start. Such gains invariably accumulate over time and can be advantageous to the ones who invest in the market early and allow their wealth to continue to accumulate.
It is common for investors to wait for the “right” time to start putting money into the stock market. As per Kavan Choksi, by doing so, many investors miss out on an important opportunity, which is to collect dividends. Investors must never underestimate dividends. The individual payout of the dividends may seem small, especially when one has been investing for just a few years, but it is vital to note that dividends are responsible for more than 40% of S&P 500 gains. Stock market investors may decide to cash in their dividends as soon as they are available, or choose to reinvest the dividends back into the market, manually or automatically.
Automatic dividend reinvestment helps expand the portfolio without much of an effort on the part of the investor. As they reinvest the dividend payouts, they shall get the opportunity to buy additional shares that earn additional dividends. Basically, dividend reinvestment can help the investors leverage the magic of compound returns. In case a person is planning to save for the retirement, it would be smart to turn off dividend reinvestment once they have stopped working. Rather they may collect the dividends paid as cash distributions that could be put toward living expenses.
