What are passive funds and how do they work?

If you’re curious about making investments and have been wondering “what are passive funds and how do they work?”, you’re in the correct place.

Today, we’re going to take a closer look at the term “passive funds” and explore how passive investing works and some of the downsides to this approach, so you can decide if this is the right type of investment for you.

What exactly is a passive fund?

A passive fund is defined as a type of investment that tracks a market index, the stock market, or a particular area of the stock market to work out where investments should be made. A passive fund manager won’t determine which securities are invested in, unlike an active funds manager. For this reason, passive funds are typically less costly to make investments in than active funds, where an expert fund manager is actively analysing and researching potential investment opportunities.

The key aim of passive funds, sometimes referred to as index or tracker funds, is to provide returns for investors in line with the present stock market. The aim isn’t always to beat it, but just to replicate the market movement the passive fund is currently tracking.

Unlike active fund managers, passive fund managers won’t select which investments to keep in the fund. This means that returns gained will depend on performance levels of the index the passive fund is tracking. Should the index or stock market an investor is tracking fail, so too will their fund.

How does passive investment work?

Among the most commonly tracked markets here in the United Kingdom, the FTSE 100 is an index of the 100 largest companies in the country, based on the share value they have. A passive fund will buy shares in every one of the 100 companies, proportionate to the market value they hold. After working out the value of the passive fund, it will then move according to any changes to the value of the index.

What are the downsides to passive funds?

Passive funds can’t beat the stock market because they only mimic the selected index in which they are invested. This means they won’t ever earn as much money as other funds that come with increased risks.

Passively managed funds often won’t involve a human manager who can update a portfolio quickly, or inform an investor when market conditions alter.

Finally, those investing in passive funds will find their options may be limited, making it difficult to create a varied and well-balanced portfolio.

Are you seeking investment advice in Chester or Shropshire?

If the answer to the question is still unclear in your mind and you’d like to discuss your options with an expert wealth manager, we can help. At Hartey Wealth Management, our specialist team can offer a comprehensive assessment of your current financial situation and provide active management of your investments.

Why not contact us today for any assistance required? We will soon be in touch.

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