How to Invest Passively

Stocks and bonds are time-honored investments that generally rise in value if you give them enough time. If you want to invest but lack the time to invest actively by selecting individual stocks and bonds, you can invest passively using index funds and exchange-traded funds (ETFs) to obtain stock- and bond-market returns. While passive index investing may not beat the returns you can expect from active investing, you will not under-perform the market either. Obtaining consistent returns in line with the overall markets is actually quite satisfying, considering that approximately 80% of mutual funds under-perform the stock market's returns every year. Here are some points to ponder when considering passive investing. [1]


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    Determine your asset allocation. A rule of thumb is to subtract your age from 100 to arrive at the percentage of your investment portfolio that should be in stocks, and the rest should be in bonds and other less aggressive choices. For example, if you are 30 years old, you should have 70% in stocks and 30% in bonds.
    • According to investment guru Benjamin Graham, your percentage of stocks should always be at least 25% and at most 75%, the same being true for bonds, in order to provide good diversification. So if you are under 25, you should have 75% in stocks and 25% in bonds. At the other end of the spectrum, if you are over 75, you should have 25% in stocks and 75% in bonds.
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    Determine the allocation of your stock money. A simple way is to pick a well-diversified, low-expense index fund or ETF that provides broad market coverage, such as Vanguard Total Stock Market ETF, which tracks the investment return of the entire New York Stock Exchange with an expense ratio of only 0.07%. The expense ratio is the percentage of your investment that a mutual fund or ETF charges annually for managing your money. For example, if you invest $1000 in a fund with a 0.07% expense ratio, you lose 70 cents per year to management fees. This fee is automatically deducted from the share price of the fund. The lower the expense ratio, the better the long-term return of the fund. Look for other index stock funds or ETFs by searching online with an ETF or mutual fund screener.
    • To diversify your stock allocation, you can, for example, allocate 50% to US stocks and 50% to foreign stocks. Since the US and foreign markets may move differently, re-balancing periodically will help you continue to buy low and sell high in each market. (See below for more on rebalancing your portfolio.)
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    Determine the allocation of your bond money. The easiest way is to allocate your bond money to a "total bond index" fund or ETF with a relatively high yield and low expense ratio. For example, the Vanguard Total Bond Market ETF has an expense ratio of 0.12%. (Vanguard has a unique corporate structure that allows it to maintain relatively low expense ratios.) Look for other bond index funds by searching online with an ETF or mutual fund screener. (See the Tip below.)
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    Open a stock brokerage account and buy the index funds or ETFs as you allocated. For example, suppose you have $10,000 to invest. If you are 50 years old, allocate 50% to stocks and 50% to bonds. You can spend $5000 to buy a broad stock market index fund or ETF and $5000 to buy a broad bond market index fund or ETF.
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    Rebalance regularly: monthly, quarterly, semiannually, or annually, depending on your preference. Re-balancing allows you to maintain the same allocation and forces you to buy low and sell high. It is also a good time to add money to your investments. Use dollar-cost-averaging by adding a set amount to your account at regular intervals, so that you buy fewer shares when prices are high and buy more shares when prices are low. This is an excellent way to accumulate a lot of shares over time.
    • Suppose you decide to rebalance quarterly, and you can add $1000 to your account quarterly, so that you start with $5000 in a stock index fund and $5000 in a bond index fund. Three months later, suppose stocks have risen while bonds have remained unchanged, so that your stocks are now worth $6000 and your bonds are still worth $5000. Stocks now make up 55% of the value your portfolio and bonds only 45%. To reestablish your original 50/50 allocation (assuming you still want that same ratio), and adding in the additional $1000 to the portfolio for a total value of $12000, you will need $6000 in stocks and $6000 in bonds. You leave the stock index fund untouched and use all the new money to buy more of the bond index fund. That leaves you with $6000 in each fund.
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    Keep your risks in check by re-balancing. You acquire more assets that are relatively cheap and fewer assets that have become more expensive. In addition, you sell shares when they rise in value and reinvest in cheaper assets. Thus, in the above example you sell stocks high and buy bonds low.


  • There are many websites offering screening help in finding appropriate mutual funds and ETFs. Among them are: Yahoo! Finance, Morningstar,, Fidelity, Reuters, and Lipper.
  • Pay no attention to daily news about the stock market, which tends to promote buyer excitement that leads to buying when stocks have gone up and then downheartedly selling when stocks have gone down. That is the opposite of buy low and sell high -- and the surest way to lose money.
  • Be patient and stick to this plan. Have a long-term perspective, and your portfolio will grow with minimal effort on your part.
  • Passive investing through index funds will minimize risks associated with individual stocks and bonds. Since each stock or bond account for a very small portion of a well-diversified index fund, any particular stock going bankrupt or bond defaulting will have a negligible effect on the index fund as a whole.


  • Watch out for fees associated with mutual funds. High fees will significantly reduce your returns, increasingly so as time goes by. Index funds tend to have the lowest fees overall (typically between 0.07 and 0.2 percent), while actively managed funds tend to have higher fees (in excess of 1%). Even seemingly small fees like these can compound into significant sums over time. In addition, look for funds with low annual turnover rates. Annual turnover rate is the percentage of a fund's holdings that is replaced each year, generating capital gains taxes that are passed on to the investor. For example, a fund with a 100% annual turnover replaces all its holdings in a year, while a fund with a 5% annual turnover replaces only 5% of its holding in a year (or all of its holdings within 20 years). Higher turnover rates mean more capital gains taxes and lower investor returns. Look for an index fund with a low expense ratio and low annual turnover. Those two factors will compound over time and make you a happy investor in the long run.

Sources and Citations

  1. The Performance of Mutual Funds, by Bill Barker, from

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Categories: Investments and Trading