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Passive Investing: What It Is and How It Works

Passive Investing What It Is and How It Works

Passive investing is an investment strategy that involves holding a diversified portfolio of securities, such as stocks, bonds, or other investment vehicles, with minimal buying and selling activity.

The goal of passive investing is to track the performance of a particular market index, such as the Nifty 50 or the Sensex, rather than trying to beat it through active management.

Passive investing approach is championed by experts like Warren Buffett and is lauded for its simplicity,as it is less time-consuming and provides built-in diversification by encompassing a wide array of stocks, potentially reducing risk.

Additionally, it minimizes trading fees due to infrequent buying and selling, allowing investors to benefit from long-term, inflation-beating returns through compound interest.

In India, passive investing has seen significant growth, with Assets Under Management (AUM) of ETFs increasing from ₹351 crore in 2014 to over ₹6,27,244 crore today. This growth is driven by the popularity of ETFs, which offer a cost-effective investment option for investors to participate in equity markets.

The attractiveness of passive funds like ETFs hinges on two critical metrics: the expense ratio and tracking error. A low expense ratio means lower costs for investors, enhancing the fund’s appeal by improving net returns. Similarly, a minimal tracking error ensures the ETF closely follows its benchmark index, crucial for matching market performance.

Despite the benefits of passive investing, it carries inherent risks, such as returns varying widely year to year, with some years experiencing significant declines.

Additionally, the growing popularity of passive funds may lead to inflated asset prices, exacerbating market downturns.

The key characteristics of passive investing are

  1. Low fees: Passive investment funds, such as index funds or ETFs, have lower fees compared to actively managed funds.
  2. Minimal trading: Passive investors buy and hold securities for the long term, reducing the need for frequent buying and selling.
  3. Diversification: Passive portfolios are designed to track a broad market index, which provides diversification and reduces risk.
  4. No attempt to beat the market: Passive investors do not try to time the market, pick individual winners, or make tactical bets.
  5. Long-term focus: Passive investing is a long-term strategy, often with a time horizon of five years or more.


Passive investing offers several benefits, including

  1. Cost savings: Lower fees can lead to higher returns over the long term.
  2. Consistency: Passive investing can provide consistent returns, as the portfolio tracks the underlying market index.
  3. Tax efficiency: Passive investing can be more tax-efficient, as there is less buying and selling, which can reduce capital gains taxes.
  4. Simpllicity: Passive investing is often easier to understand and implement, as it involves tracking a broad market index rather than trying to pick individual winners.
  5. Evidence-based: The majority of academic research suggests that passive investing is a more effective strategy for most investors.


Some common types of passive investing include

  1. Index funds: These funds track a specific market index, such as the Nifty 50 or the Sensex.
  2. ETFs (Exchange-Traded Funds): These funds track a market index, but trade on an exchange like stocks.
  3. Sectoral ETFs: These funds track a specific sector or industry, such as banking, IT, or pharma.
  4. Gold ETFs: These funds track the price of gold, providing investors with a way to invest in gold without physically holding it.

Overall, passive investing is a popular strategy for individual investors, institutional investors, and financial advisors, as it offers a low-cost, efficient, and evidence-based approach to investing.


Popular Passive Investment Options in India

  • Nifty 50 Index Funds
  • Sensex Index Funds
  • Nifty Next 50 Index Funds
  • Sector-specific ETFs (e.g., banking, technology)
  • Gold ETFs


Are There Any Risks Associated with Passive Investing?

  • Market Risk: Passive funds are subject to market fluctuations, and their value may decline if the underlying index performs poorly.
  • Tracking Error: Passive funds may not perfectly track their underlying index, resulting in a tracking error.
  • Liquidity Risk: ETFs may have lower liquidity compared to other investment options.



Passive investing is a popular strategy for those looking to achieve consistent market returns with lower costs and reduced complexity. By focusing on index funds and ETFs, investors can build a diversified portfolio that aligns with the overall market performance.


Frequently asked questions

Q: How do I get started with passive investing in India?

A: To get started with passive investing in India, you can:

  • Open a demat account: Open a demat account with a brokerage firm or a mutual fund house.
  • Choose a passive fund: Select a passive fund that tracks a particular market index, such as the Nifty 50 or the Sensex.
  • Invest regularly: Invest a fixed amount of money at regular intervals, such as monthly or quarterly.
  • Monitor and adjust: Periodically review your portfolio and rebalance it as needed to ensure it remains aligned with your investment goals.

Q: Are passive investments in India regulated?

A: Yes, passive investments in India are regulated by the Securities and Exchange Board of India (SEBI). SEBI sets guidelines and rules for mutual funds, including passive funds, to ensure they operate in a fair and transparent manner.

Q: Can I invest in passive funds through a Systematic Investment Plan (SIP)?

A: Yes, you can invest in passive funds through a Systematic Investment Plan (SIP). A SIP allows you to invest a fixed amount of money at regular intervals, which can help you take advantage of rupee-cost averaging and reduce market volatility.

Q: Are passive investments in India suitable for all investors?

A: Passive investments in India can be suitable for most investors, including beginners, who want a low-cost, long-term investment strategy. However, it’s essential to assess your investment goals, risk tolerance, and time horizon before investing in any asset class. It’s also recommended to consult with a financial advisor or conduct your own research before making an investment decision.

Q: How do I choose the right passive fund for my investment goals?

A: To choose the right passive fund for your investment goals, consider the following factors:

  • Expense ratio: Look for funds with low expense ratios.
  • Tracking error: Look for funds with low tracking errors.
  • Index tracked: Choose a fund that tracks a market index that aligns with your investment goals.
  • Fund manager: Look for funds with experienced fund managers.

Q: Can I use passive investing for my retirement savings?

A: Yes, passive investing can be a suitable strategy for retirement savings. Passive funds can provide a low-cost and diversified way to invest for the long term.

Q: How often should I review my passive investment portfolio?

A: It’s a good idea to review your passive investment portfolio periodically, such as every 6-12 months, to ensure that it remains aligned with your investment goals and risk tolerance.

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