Passive investing is one of many investment strategies available to Canadian investors. In simple terms, passive investing is the practice of buying assets and earning an income with little to no involvement from the investor. On the contrary, active investing requires dedication and consistency to earn investment income. To learn more about passive investing in Canada, continue reading.
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What is Passive Investing?
Passive investing in Canada is a type of investment strategy that attempts to optimize returns by reducing buying and selling. In other words, passive investing involves buying an asset and holding it for a long period of time. Once the asset is owned, the investor doesn’t partake in many actions to earn income, but rather relies on the asset to appreciate and distribute income over time. Another reason why passive investing is often used is to avoid the fees and other costs associated with frequent trading that eats into profits.
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Types of Passive Investing in Canada
There are three main types of passive investing in Canada: index, direct equity, and exchange-traded funds. Let’s take a closer look below:
Index Funds
Index funds purchase and hold stocks and other assets, then attempts to replicate a particular index, such as the S&P 500 Index. The fund manager is responsible for tracking performance against the index. This allows the investor to engage in passive investing because all they need to do is buy into the fund and then watch their money grow.
Direct Equity
Direct equity is similar to index funds, except the fund manager is cut out of the equation. Instead, the investor purchases stocks within an index at the same proportion of the index. In theory, the returns of the investor would track against the returns of the economy. However, the investor would essentially absorb the responsibility of the fund manager which can be a challenge. Although, it also means greater profits for the investor because there’s no management expense ratio to pay.
Exchange-Traded Funds (ETFs)
Exchange-traded funds, or ETFs for short, are similar to index funds in many ways. The main difference is ETFs are listed on stock exchanges. Every time an ETF is bought or sold, there is a transfer of ownership.
Other types of passive investing in Canada
In essence, passive investing is any kind of investing that involves little to no effort of the investor to produce income. Here’s some other common instances of passive investing in Canada:
- Investments with a yield. Any investment that yields dividends or other income with little to no effort from the investor is a form of passive investing. This is because your investment is earning money while the investor is only engaged in ownership.
- Utilizing robo-advisors. Using a robo-advisor is a form of passive investing because an algorithm is doing all the work for you.
- Assets that appreciate. Any asset you own that appreciates without your active engagement is considered passive investing. For instance, if you buy art that hangs on your wall for years and it appreciates in value.
- Savings accounts, bonds, GICs and more. These accounts yield interest on your principal. All you need to do is put your principal into the investment and you’ll earn passive interest.
What is the best passive income in Canada?
Generally speaking, any passive income paid in the form of dividends is the best passive income in Canada. This is because dividend income is taxed at a lower rate compared to interest income or capital gains. Both interest income and capital gains are fully taxable, but dividends provide access to a tax credit. You can access this type of passive income by purchasing stocks, funds and ETFs that yield dividends.
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Advantages of Passive Investing in Canada
- Low fees. Since passive funds follow an index as their benchmark, the cost of picking stocks and other assets is much lower. In addition, investors save money when they aren’t constantly buying and selling stocks and other assets.
- Set it and forget it. Passive investing very much involves setting it and forgetting it. This can ease anxieties around constantly buying and selling.
- Tax efficient. By holding onto assets for long periods of time, the investor is delaying capital gains tax.
- Simple. Passive investing is a fairly simple investment strategy to follow. It can be used and understood easily by the beginner and expert investor. It also takes a minimal amount of time to learn and implement.
- Diversity maintained. Investors can still engage in diversification strategies while passive investing.
Disadvantages of Passive Investing in Canada
- Limited options. Because passive investing is usually tracked against an index, fund managers have less choice when it comes to choosing assets to put in the fund.
- Smaller potential returns. The potential profits can be smaller compared to other investment strategies. In addition, there is an opportunity cost for higher gains elsewhere.
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How can I make $50,000 a year in passive income?
There are a few ways you can earn $50,000 a year in passive income. For example, if you have $1 million as a principal and you invest in stocks that yield 5% in dividends annually, you’ll earn $50,000 a year in passive income. For another instance, let’s say you have $500,000 and find a 10-year GIC that pays 10% interest, you’ll earn $50,000 a year. As you can see above, in order to earn a reasonable passive income, you have to have a big principal!
Passive investing is an understandable investment strategy that can be implemented into your personal finances with ease. It also allows you to free up time to do other things while your money grows in the background. Consider utilizing passive investing strategies today!
Read More: Asset Classes in Investing: An Overview