Free Essay Sample: Passive Investment Strategy in The Stocks Market

An investment strategy is a step-by-step plan that aims at allocating assets that are investible among many investment options such as the government bonds, hares, real estate, etc. The investment plans are defined by some factors in the economy such as bank rates, inflation and also economic plans among others. The corporate investment plans give a specification on the number of funds needed to acquire a competitive benefit and even the profits that are expected from those decisions. One of the investment strategies includes passive investing which is a strategy that is aimed at profit maximization in the long run by holding a minimum of the buying and selling amounts. The main idea in this strategy is to evade the performance fees and the drag-on that potentially happens when trading frequently. This strategy is not geared towards making quick profits or reaping huge returns from one great gambling, but instead, it is aimed at creating wealth through a slow and steady manner over a specified period.

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Passive investment is a financial plan that tries to equate the market performance. Inside the passive portfolio, the passive managers will start with a universe of securities that are valid for trading and then sort them out under the basement that there are high caps and small caps and also the fundamentals of growth and value. Passive investors do not forecast or do market predictions and timings. A passive investor who seeks to seize the returns from stocks doe not determine which company is preferable to the other and also does not dwell on the state of the economy; if the economy is growing, stagnant or contracting. What these passive managers do is to hold out the idea that the markets remain efficient to mean that they quickly adapt to the latest market formations and that there are fair prices (Grossman, S. & Stiglitz, J., 1980, 393).

A passive investment strategist usually has their portfolios build based on principles of allocating assets and the use of index funds of low cost. These principles used are all proven within the economy in question. The advantage of index funds is that they allow for reduced expenses incurred during operation and trading. They also offer great diversification in the various categories of assets together with providing comprehensive access to the different market segments. Managers of index funds have their portfolios constructed to estimate how well market benchmarks are organized. The index managers buy stock and hold them in the same fraction that is existent in the market or a segment of the market. For instance, there are large companies in the United States as well as small companies; there are also large companies that operate internationally; all these companies result in a portfolio with a lot of stocks. Each of those categories of companies has their indexes (Sackett, B., 2002, 78). Some other renown indexes will measure shares of small companies, high-value stocks, foreign stocks, real estate stocks, precious metals commodities, etc.

The passive investment strategy bases its arguments on the theorem that markets are efficient commonly referred to as the efficient market hypothesis. This hypothesis states that the price of the current stock is a reflection of all the relevant data on its current gains as well as the future earnings. The possibility of this hypothesis is that when the prices of stocks change, it implies that a company information change triggered a change in the stock prices (Wolla, S., 2016, 3). For example, when you learn that company X just received a patent on a given new product, then you will consider buying stocks from company X because you expect that the new product will gain massive amounts of profits from the company X and their investors. It is also essential to note that you are not the only investor who make the decisions of undervaluation of company X stock and you are ready to pay a higher price for the stock. When there is an indication that a stock's value is lower than it should be, the participants in the market give a response to this change by purchasing the stock by bidding for the share with a higher figure. When information gives an implication of an overvalued stock, the market response is that the investors sell their shares quickly resulting into a downward pressure to the stock's value and this moves the price back to its fair amount. The efficient market hypothesis argues that any new information about a particular share comes with a price-either lowering or raising the value of that stock. Due to that reason, the theory holds that market price reflects the price of shares under the basis of the currently available data on a given share. Consequently, the theorem states that the best strategy, when all information available leads to change in prices of stock, is to purchase a diversified portfolio and hold it, and another approach in such cases would be to minimize investment costs (Malkiel, B., 1989, 128).

The passive investment strategy maintains that the market for stocks is very efficiently such that the active managers will not defeat the market consistently because the will not pick undervalued stocks quite often. And again, the extra costs incurred through actively managed mutual funds, these funds are passed on to the investor, when doing research and transactions usually offset the gains. Although some other actively managed mutual funds beat the market, data shows that there is a consistency in the failure of those active investors to outsmart the market averages which various indexes report (Malkiel, B., 1989, 128).

In conclusion, Passive investment strategy in the stocks exchange market assumes an efficient market such that communication of data to the investors plays a crucial role in making purchase decisions and not the behavior of the economy. Recently there has been a hot debate on the expansion of funds that are managed passively. Since there is a small share of portfolios of passive funds in the shares and securities holdings, there could be no substantial effect on the price of stocks. However, as the passive strategy continues to grow, the results could become significant over time.

References

Grossman, S.J., and Stiglitz, J.E., 1980. On the impossibility of informationally efficient markets. The American economic review, 70(3), pp.393-408.

Malkiel, B.G., 1989. Efficient market hypothesis. In Finance (pp. 127-134). Palgrave Macmillan, London.

Sackett, B.C., 2002. Stocks for the Long Run: The Definitive Guide to Financial Market Returns and Long-Term Investment Strategies. Journal of Investment Consulting, 5(2), pp.78-78.

Wolla, S., 2016. Stock Market Strategies: Are You an Active or Passive Investor?. Page One Economics Newsletter, pp.1-4.