What is a Hands-Off Investor?
A hands-off investor invests their money and loosely manages it over a long period of time. Investors who passively manage their money believe in market efficiency.
- Hands-off investing involves investing money and letting it accumulate over time, rather than actively managing it.
- Anyone can easily invest money using the hands-off strategy by investing their money into index funds.
- Investors who apply the hands-off strategy assume that markets are informationally efficient.
Why Would an Investor be Hands Off?
Hands-off investing is a commonly applied strategy used to passively manage money when time is scarce for an investor. The strategy enables the investor to spend minimal time monitoring and researching each security within their portfolio. Retail investors especially find the hand-off method of investing to be convenient and efficient.
The hands-off investing strategy is especially attractive when an investor opts to take an indexing approach. Indexing is a passive investment strategy for gaining targeted exposure to specific market segments.
Indexing is a strategy that minimizes transaction costs. Investors will purchase index funds, a fund of funds with mutual funds, or exchange-traded funds as their primary holdings. Specific indexes an investor could buy when indexing include:
- S&P 500 Index
- Dow Jones Industrial Average (DJIA)
- FTSE 100 Index
- Nasdaq Composite
- Nikkei 225
- Russell 2000 Index
- Hang Seng Index
What is Passive Investing?
Passive investing is an investment strategy applied by investors who hope to maximize return through the minimization of transactional costs. It is common for investors to simply purchase a benchmark index and hold it over a long time horizon with reinvested dividend payments.
Index investing is the most popular form of passive investing because investors are easily able to replicate the returns of a well-established market index.
The primary reason why passive investment strategy is so popular is that the market generally will post positive returns over a long enough time horizon. Another distinct advantage of being a hands-off investor is that purchasing an index fund can help achieve the maximum diversification benefit.
Diversification is necessary to reduce idiosyncratic risk, and therefore, the portfolio will only be subject to market risk. This market risk is synonymously known as undiversifiable risk, volatility, or systematic risk.
How Does Market Efficiency Relate to Passive Investing?
If investors believe that market prices are informationally efficient, the market price must reflect all known information about the security.
Therefore, the investor does not believe that securities can be overpriced or underpriced and will simply invest in an index of risky assets. The index serves as a proxy for the market portfolio and allocates a portion of their investable assets to short-term government securities or other risk-free assets.
Active investment strategies will underperform due to transaction costs and management fees. Actively managed funds can generate more return than a passively managed fund, but that comes at the expense of increased risk.
To the extent that markets are inefficient, active investment strategies can generate positive risk-adjusted returns.
What are the Advantages of Being a Hands-Off Investor?
Hands-off investing is becoming a highly popular investment strategy by retail investors for a multitude of reasons. Its advantages include:
1. Minimal transaction cost
A passively-managed portfolio means that the investor will not be rapidly entering and exiting positions and incurring transaction costs.
It is simple for investors to buy and hold index funds because it does not require continuous market research and rebalancing. The ease of investing in exchange-traded funds has made hands-off investing significantly more popular.
Investors can easily view what specific securities are being held in an index fund before purchasing. Moreover, investors can go online and see what proportion of their return is allocated to each security.
4. Tax Efficiency
The hands-off strategy prevents the investor from realizing capital gains and avoids capital gains taxation. This only holds true if the security is being held outside of a registered account.
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