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Passive investing more popular than ever – how to invest

With passive investing on the rise, we look at the pros and cons of investing in passive (index or tracker) funds and share four new fund ideas.
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Important information - This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Passive investing with index (or tracker) funds is one of the simplest ways to invest in the stock market.

Passive funds have been around since the 70s and are offered by a range of investment companies. They aim to track the performance of a particular index, or stock market, like the FTSE 100, made up of the UK's biggest companies.

In 2023, total global assets under management in passive funds surpassed active ones for the first time. And for the past nine years, more’s been invested in passive funds in the US than active funds (where a manager picks the stocks).

Over 10% of our client investments are now held in index funds. The number of clients choosing passive funds as their main investment is up 80% over the last two years.

But how do passive funds work and what do investors need to know?

This article isn't personal advice. If you're not sure if an investment is right for you, ask for financial advice. Investments can fall as well as rise in value, so you could get back less than you invest.

How does passive investing work?

Most index funds typically invest in every stock from the index it's following – known as full replication. Some won't invest in every stock, but they'll hold a sample of shares which represent the wider index – known as partial replication.

Buying and selling companies involves costs, which can eat away at performance. To keep the fund's performance as close to the index as possible, passive funds use techniques like reinvesting dividends to keep costs to a minimum.

Passive funds can add exposure to a wide variety of companies to your portfolio through just one investment.

What are the benefits of passive investing?

  • Low cost – they track an index which means there’s no research costs for choosing investments. They also aim to make less purchases and sales, reducing dealing charges.

  • Transparency – because they’re trying to track a particular index, it’s often clear what you’re investing in if you know what’s in the index.

  • Diversification – an index usually contains lots of companies, so you’re not holding all your eggs in one basket.

What are the risks of passive investing?

  • Smaller potential returns – passive funds track the market, so there are less charges. But you’re unlikely to get market-beating returns, in fact you will often slightly underperform the market because of charges.

  • Less control – the fund might buy everything in the index, so you can be more exposed to certain types of investment. Like in the S&P 500, where technology makes up a big part of the index. There are tracker funds that exclude investments for environmental, social and governance (ESG) reasons.

What are the benefits of active investing?

  • Flexibility – fund managers can pick and choose investments based on what they think will perform well over the long term. They could find undervalued companies the market might have overlooked.

  • Performance – they have the opportunity to outperform the stock market.

  • Risk management – active funds can choose to sell holdings when they think they might form too much of the fund. This can avoid investors being overexposed to certain companies or industries.

What are the risks of active funds?

  • Higher charges – fund managers pick individual investments, so higher research costs can make active funds more expensive.

  • No guarantee of outperformance – a lot of fund managers don’t outperform the market, especially after fees.

Investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

The best of both?

You don’t have to pick just active or just passive funds. You can choose to buy both and blend them together in your portfolio.

For example, some investors might think some markets are well researched and the prices of the investments in that market are fairly priced. So, fund managers might not be able to find unloved stocks that outperform the market. In this instance, they might choose a tracker.

But in other areas like frontier markets or smaller companies, where companies are less researched, a fund manager might be able to find companies that will perform well.

Introducing our new low-cost Multi-Index funds

We’re launching a new range of low-cost multi-Index funds. There are four funds to choose from based on the level of risk you want to take. And it’s the only investment you need.

These funds are made up of investments that track markets, keeping costs down but are managed by expert fund managers.

The managers will manage it day-to-day, picking investments that track the market. They’ll manage the portfolio aiming to get the best return for your chosen level of risk over the long term. So, you just need to check in every so often (we suggest every six months) to make sure it’s still right for you.

You can invest from just £100 as a lump sum or £25 as a monthly direct debit.

Invest by 11:59pm 5 June to get the fixed £1 launch price.

HL Funds are managed by HL’s sister company, Hargreaves Lansdown Fund Managers Ltd.

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Written by
Charlie Hutchence
Charlie Hutchence
Investment Writer

Charlie is a part of our writing team that covers investments and ISAs. He's passionate about the value of long-term investing and making your money work harder for you, using his writing to help our clients make the most of their money.

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Article history
Published: 14th May 2024