An intro to passive investing

Jan 24, 2018 · 476 words · 3 minutes read Investing

For the past few months I’ve been interested in passive investing. I read books, did research online and have been investing a portion of my savings.

Many of the things I read are targeted to investors living in the US. Fortunately, a lot of the knowledge carries over to any other country. Still, while investing myself, I encountered Belgium-specific things that I had to figure out. Therefore, if you’re living in Belgium and are getting into passive investing, this series of posts could be useful to you.

Why passive investing?

These days, the interest offered on your savings account is very low. For instance, my bank BNP Paribas Fortis offers an interest rate of 0.11% on my savings account. At the time of writing, the inflation rate of the Eurozone is at 1.4%. This means that I am losing buying power year-on-year if I keep all my money on the savings account.

In those conditions, it makes sense to have your money somewhere that gives you a return at least as high as the inflation rate (in that case you don’t win buying power but also don’t lose any). Passive investing means investing in low-risk securities that yield good returns when invested for the long-term and that don’t require a lot of trading (as opposed to active investing where you trade daily or multiple times per day).

Spread the risks

The S&P 500, i.e. the 500 biggest American companies, has had an average yearly return of 10% since its inception in 1928. As you can see on this table, it has hit returns as high as 52% (in 1954) and lows as low as -43.84% (in 1931). However, if you take a long-enough time period such as 30 years, the average return rate will be around 10%. The ever-increasing productivity due to technology and economical progress is at the root of this positive return.

That is a lot higher than the 0.11% interest rate! The key to passive investing is that you invest in a collection of stocks rather than an individual stock. This greatly lowers the risk as it spreads your bets across an entire industry (e.g. technology), geographical region (e.g. emerging markets) or even the entire world. By investing in a set of diverse high-risk stocks, you lower the risk of the entire portfolio. This is the basis of Modern portfolio theory.

Index funds and ETFs

You’ll find many books and resources talk about index funds, such as those offered by Vanguard. Unfortunately, these are not available to us in Europe but we have access to something similar called an ETF (Exchange-Traded Fund). There are differences between ETFs and index funds but the main point is that both follow a collection of stocks instead of an individual stock.

How do I start investing in Belgium?

Please see my next post Passive investing in Belgium.