Passive investing
An approach that buys a broad basket of securities, typically by tracking an index, to earn the return of the asset class as a whole rather than trying to beat it.
In plain language
Not every investor tries to pick winners. Some simply want the market's own return, delivered as cheaply as possible.
That is passive investing. Instead of studying individual companies, the investor buys a broad basket — most often all the securities in an index — and holds it. There is no attempt to decide which stock is worth more than its price and which is not.
How it works
The workbook: "Passive investing involves investing in a broad set of securities that fairly represent the asset class the investor needs to invest... The objective of a passive investor is to earn the rate of return that the select asset class provides." A passive investor holding an index fund that tracks all 50 constituents of the Nifty 50, for instance, makes no decision on any one of those 50 stocks individually.
This sits opposite active investing, which involves constantly buying and selling specific securities against their intrinsic value. Passive investing needs far less effort and far fewer transactions, which is also why it is usually cheaper to run.
A worked example
Illustrative. An investor puts Rs 5,00,000 into a Nifty 50 index fund with a total expense ratio of 0.2% a year. The fund simply buys all 50 index constituents in their index weights and holds them.
If the Nifty rises 12% over the year, the investor's holding grows to roughly Rs 5,60,000 before costs, and around Rs 5,58,880 after the 0.2% fee is deducted. The investor never decided to buy or sell any individual stock in the index — the return simply followed the index up.
Why NISM asks about it
Chapter 4.1.1 and 4.1.2 set active and passive investing side by side. Expect a question contrasting the two, or one testing that a passive investor's decision stops at the asset class, without picking individual securities.
Common exam traps
- Passive investing is not risk-free. It still carries the full downside of the index it tracks — it removes stock-picking risk, not market risk.
- Buying an index fund selectively, based on a view that it looks cheap, blurs into active investing. True passive investing is defined by holding the broad asset class regardless of view.
Where this is taught
Free preparation for NISM Series XVRelated terms
- Active investingAn investing approach that involves picking individual securities to try to beat the return of the broader asset class, rather than simply tracking it.
- Efficient Market HypothesisThe proposition that share prices already incorporate and reflect all relevant information — which, if true, leaves nothing for an analyst to find by studying that information.
- Fundamental analysisEstimating what a share is worth from the profits and cash flows the business will generate, then buying only when the market price sits below that estimate.
- IndexingBuilding a portfolio that mirrors an index constituent by constituent — the most common form of passive management, carried out either by full replication or by sampling.
- Index inclusion effectThe portfolio and price impact when an index rebalance adds or drops a constituent: full-replication funds must buy the entrant and exit the leaver in full, on the same date, whatever the price.