There are two very broad types of investing -- active and passive -- which refer to the way funds are managed. Active management means the portfolio manager actively trades in and out of the portfolio to help the fund beat its benchmarks based on his or her investment criteria or other factors.
Passive management is a more hands off approach, as the fund invests in a benchmark or index. Over the past decade, passive investments have outperformed active funds, on average, due to the long bull market that ran throughout the 2010s.
While active management is typically related to fund management, it could also apply to individual investors, like day traders and swing traders, who trade stocks frequently trying to time the market and ride the wave for short-term gains. But that can go the other way, too, as you can be left holding the bag when the stock heads south and you end up selling for a loss.
For investors who have been burned by a volatile stock or underperforming actively managed fund, an investment in a passively managed exchange-traded fund (ETF) can help you avoid worrying about the market's short-term ups and downs while generating long-term returns.
Since the S&P 500 first launched back in 1926 (it only had 90 stocks then), the index has averaged a 10% annual return. But there are thousands of ETFs available that track many different benchmarks. Here are 2 great passive investments that should generate long-term returns without much stress, as they are both designed for low volatility.
Invesco S&P 500 Low Volatility ETF
This ETF is a great option for investors who are concerned about volatility. The Invesco S&P 500 Low Volatility ETF (NYSEMKT: SPLV) invests in the S&P 500 Low Volatility Index. If you are not familiar with this benchmark, it consists of the 100 stocks from the larger S&P 500 Index that have had the lowest volatility over the past 12 months. Volatility is measured by the magnitude of up and down price fluctuations. The ETF is reconstituted each quarter, so the fund will rebalance accordingly.
Currently, the largest holdings in the ETF are Verizon, Proctor & Gamble, Hershey's, and PepsiCo. About 29% of the portfolio is in large-cap blend stocks, while 27% is in mid-cap blend, and 24% is in large-cap value. Only 6.6% is in large-cap growth.
The returns have been steady and solid. Year-to-date (YTD), the fund has returned about 13% as of Oct. 26. Its five- and 10-year annualized returns are 10.6% and 12.8%, respectively. Since inception in 2011 it has returned 12%. These returns all trail the S&P 500, but it has been a very good past decade for the markets. If you are concerned about volatility going forward, this is a solid option.
SPDR SSGA US Large Cap Low Volatility Index ETF
This ETF is similar to the Invesco ETF in that it strives for low volatility. But the SPDR SSGA US Large Cap Low Volatility Index ETF (NYSEMKT: LGLV) casts a slightly wider net, as it screens for the least volatile stocks from the Russell 1000. The stocks exhibiting the lowest volatility, based on its measures, receive the highest weights. It is also rebalanced quarterly.
The fund currently contains roughly 139 holdings, slightly more than the Invesco ETF. Its three largest positions are American Tower, Public Storage, and Republic Services. The sectors most represented are industrials (17.2%), financials (16.3%), and information technology (13.8%).
The ETF is up about 19% YTD as of Oct. 26. For the five-year period ended Sept. 30, it has posted an annualized return of 13.9%. It does not have a 10-year track record yet, but since inception in 2013 it has an annualized return of 13.3%. It also has a low expense ratio of 0.12%, compared to 0.25% for the Invesco ETF. These returns also trail the larger benchmark from which it is derived, the Russell 1000, but again, that was a strong decade for the overall market.
But the utility of these funds is to provide ballast to a portfolio to weather the ups and downs of the market while generating long-term returns. In that role, they might be a nice fit in a diversified portfolio.
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