July
by Colin Nicholson
Most investors fall into two groups: passive investors and active investors. This month we will look at passive investing; next month we will visit active investing.
Passive investors are also known colloquially as buy-and-hold investors, which describes what they do. Passive investors invest their savings gradually over their lifetime in sound businesses. They then hold those shares long term in the expectation of enjoying a growing stream of dividends and growth of the value of the shares.
This does not mean that they will not change their holdings of shares over time, but those changes will generally be prompted by a small number of reasons such as:
- Takeovers and mergers
- Demergers of large company groups
- Rebalancing of the portfolio
- Newly floated companies
- Long term decline in the prospects or performance of a company
- Because passive investors are investing their savings as they become available, their investments will be made gradually over time and therefore through the various stock market cycles.
For the passive investment method to work there are some key requirements:
- If investing through managed funds, focus on those with a good performance record and low fees. Do not chase last year’s best performing fund. Research shows that this does not work very well.
- It is mandatory to sit through bear markets. The worst thing a passive investor can do is to panic and sell near the bottom of the cycle.
- Passive investors can only achieve the previous requirement if they hold a cash reserve to last them through two to three years. Alternately, the dividend stream is taken in cash and used to meet living expenses rather than being reinvested.
The passive investment method can work very well, especially where dividends are reinvested so that they compound over time. However, it requires considerable patience and an iron discipline.
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