4 Reasons Passive Management Works

Many mutual funds use passive management strategies in their portfolios. This type of management has been proven to provide investors with good results in the majority of cases. Here are a few reasons that passive management works.

1. Historical Performance

When you use a passive investment strategy, you have history on your side. Over the entire history of the stock market, you will find that it always tends to go up. Although you will experience downturns in the market, over the long term, the market will always move upwards. Therefore, if you use a passive investment strategy and hold your securities over the long term, you will be able to benefit from the overall gains in the stock market.

2. Avoid Timing Problems

Investors that try to time the market usually end up on the wrong side of a transaction. When you try to actively trade stocks, there is a good chance that you will get in or out at the wrong time. You might decide to buy a security because you think it looks like it will go up. However, the time to buy a security is not when it is already on the way up. You need to get in when everyone else is getting out. When a stock looks like it is bottoming out is the best time to buy. Most investors do not have the courage that is necessary to make tough investment decisions. They typically act on emotion and sell after a security has gone down significantly in price. If you use a passive investment strategy, this will not be a problem. You simply buy and hold and then forget about it. Timing will not be an issue because the price in the market will always go up over time.

3. Transaction Costs

Those that get involved in active management will have to worry about transaction costs. When you buy and sell securities, you will have to pay a commission to a broker in order to do so. When you do this frequently, the transaction costs can really add up. This extra cost will directly cut into your returns. This means that you will have to make up for this cost through better performance. When you use a passive form of management, you will not have to worry about transaction costs as much. You will buy a security and then hold it for a long period of time. Therefore, the transaction costs will be negligible. If you are not making substantial returns through active management, the transaction costs can make the strategy very ineffective.

4. Avoid Over-Analyzing

Many traders that get involved in active management suffer from problems with over-analyzing. They evaluate and reevaluate every move that they make. They will look at many different trading strategies and indicators in order to try to gain some type of advantage on the market. When this happens, you will be dealing with the phenomenon known as "analysis paralysis." This can lead to further problems with future trades and cost you money. This problem can be avoided by utilizing passive management strategies.

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