What is passive investing?
Passive investing involves buying a diversified, low-cost portfolio that follows broad market movements. Rather than picking individual stocks and trying to beat the market, passive investing offers lower fees, stronger long-term performance, and greater tax efficiency. It's a straightforward approach that has gained popularity among investors who prefer to let their money grow steadily over time.
What is passive investing?
Passive investing is the practice of buying a broadly diversified, low-cost portfolio — usually one designed to track a market index or benchmark — and holding it over time. Rather than trying to outperform the market through frequent trading, passive investors aim to capture overall market returns by owning a wide range of securities at minimal cost.
The approach is grounded in the belief that markets are generally efficient — meaning most available information is already priced into securities — so consistently outperforming through active trading is extremely difficult. By owning the entire market and minimizing fees, passive investors aim to keep more of what the market delivers.
There is a significant body of research supporting this view. Studies consistently show that this passive approach has, over time, outperformed the majority of active investors attempting to beat the overall market.
Passive vs. active investing
If passive investing is about letting your money follow broader market movements, active investing involves far more hands-on work: market forecasts, frequent trades, and attempts to gain an edge over other investors.
There are three main factors that make passive investing a particularly appealing alternative to active investing:
Fees: passive funds charge significantly lower management fees
Long-term market performance: passive funds have historically matched or exceeded most active funds over extended periods
Tax efficiency: less frequent trading leads to fewer taxable events
Fees
For decades, many investors built portfolios using actively managed mutual funds — funds run by professionals who buy and sell securities in an attempt to beat the market. These professionals don't work for free: they're supported by teams of researchers, analysts, and traders, and the cost of these teams is passed on to investors in the form of management expense ratios (MERs).
MERs are expressed as a percentage. While the percentage might look quite small, like 1% to 2%, it's shaved off the value of the entire fund annually — whether or not the fund made or lost money.
Fees add up, especially when you consider that MERs don't cover the whole fee picture. Additional costs include:
Trading costs: the amount the fund pays to trade one investment for another
Front- or back-end loads: sales commissions charged when buying or selling fund units
Over time, paying high fees can materially reduce long-term investment outcomes.
Performance
High fees might be justified if fund managers were consistently delivering returns well above their benchmarks. But it doesn't usually work out that way. Research consistently demonstrates that the majority of actively managed funds usually fail to outperform passive investments over the long term.
Tax efficiency
One often overlooked advantage of passive investing is its tax benefits. Capital gains taxes are assessed whenever investments are sold for more than their purchase price.
Actively managed funds tend to buy and sell more frequently, which could trigger capital gains. Passive strategies trade less often, which means fewer taxable events.
For exchange-traded funds (ETFs), trades usually happen between investors on the stock exchange, so the fund itself doesn't need to buy or sell its underlying investments. In contrast, when investors buy or sell mutual fund units, they're transacting directly with the fund, which may trigger buying or selling inside the fund and lead to taxable activity.
Pros and cons of passive investing
Like any investment approach, passive investing has both strengths and limitations. Understanding them can help you decide whether this strategy aligns with your goals.
Advantages of passive investing
Lower fees: passive funds typically charge much lower MERs than actively managed funds, which means more of your money stays invested and compounds over time.
Simplicity: you don't need to research individual stocks or time the market. A passive portfolio can be built with a handful of funds that track major indices.
Consistent long-term returns: by tracking a broad market index, passive investors capture overall market growth without relying on a single manager's decisions.
Tax efficiency: less frequent trading means fewer capital gains events, which can reduce your tax burden — especially in non-registered accounts.
Transparency: index-tracking funds hold the same securities as their benchmark, so you always know what you own.
Disadvantages of passive investing
No outperformance potential: passive funds are designed to match the market, not beat it. During periods when skilled active managers excel, passive investors will capture the average return.
Market downturns: a passive portfolio follows the market in both directions. When markets fall, your portfolio will fall with them — there's no manager stepping in to reduce exposure.
Limited flexibility: passive funds track a set index, so you can't tilt your holdings toward specific sectors or themes without adding additional funds to your portfolio.
Tracking error: while passive funds aim to replicate an index, small differences in performance can arise from fees, cash holdings, or timing of trades within the fund.
How does passive investing work?
If you believe that passive investing may be the strategy for you, ETFs could be a solution worth exploring. ETFs are investment wrappers that allow you to buy a large basket of individual stocks or bonds in one purchase. These funds often track an index, such as the S&P 500 or the TSX Composite, and are traded throughout the day like individual stocks.
ETFs typically have much lower MERs than actively managed mutual funds — usually between 0.05% and 0.25%. This is because these funds are largely rules-based strategies that replicate an index rather than being managed by teams of expensive professionals.
Key features of ETFs include:
Automatic rebalancing: the ETF provider handles behind-the-scenes maintenance, such as adjusting individual holdings to maintain proper market exposure
Easy to purchase: you need an account at an online discount brokerage, funds to invest, and a decision about which ETFs to buy
Variety: while broad market ETFs are the most common, specialized options include leveraged ETFs, inverse ETFs, and actively managed ETFs (which have higher associated fees)
Index mutual funds offer similar benefits with slightly different structures — they are priced once per day rather than traded throughout the day. Caution is warranted when using leveraged, inverse, or actively managed ETFs. Leverage magnifies both gains and losses, inverse ETFs move opposite to the market, and actively managed ETFs come with higher fees — the very thing passive investing sets out to minimize. All three suit short-term, tactical plays more than a long-term, buy-and-hold strategy, so it helps to know how each one works first.
Passive investing strategies
However you decide to invest your money, diversification remains a foundational principle. Proper diversification means spreading investments across different asset classes (stocks, bonds, others), geographic regions, and sectors to reduce overall risk.
Diversification helps prevent unnecessarily large losses if one of the asset classes, countries, or sectors falters. Beyond diversification, there are several well-established passive investing strategies worth understanding.
Index investing
Index investing is the foundation of the passive approach. It involves buying funds — typically ETFs or index mutual funds — designed to replicate the performance of a specific market index.
In Canada, common benchmarks include the S&P/TSX Composite Index for domestic equities and the S&P 500 for U.S. exposure. By holding a fund that tracks one of these indices, you gain exposure to hundreds or thousands of companies in a single purchase.
Buy and hold
The buy-and-hold strategy is straightforward: purchase your investments and hold them for the long term, regardless of short-term market fluctuations. This approach avoids the costs and emotional pitfalls of frequent trading. It requires patience and discipline, particularly during market downturns, but it allows compound growth to work in your favour over years and decades.
Dollar-cost averaging
Dollar-cost averaging (DCA) involves investing a fixed amount of money at regular intervals — say, $500 every month — regardless of market conditions. When prices are lower, your fixed contribution buys more units; when prices are higher, it buys fewer. Over time, this approach can smooth out the impact of volatility and removes the pressure of trying to time the market.
How to get started with passive investing
Getting started with passive investing doesn't require deep financial expertise. Here are some practical steps to consider.
Define your goals and timeline: are you saving for retirement in 30 years, or building an emergency fund for the next 5? Your investment horizon helps determine the right mix of stocks and bonds.
Open an investment account: you'll need an account through a brokerage that offers access to ETFs or index funds. Consider using a registered account — such as a registered retirement savings plan (RRSP) or tax-free savings account (TFSA) — for tax advantages.
Choose your funds: look for low-cost ETFs or index funds that track broad market indices. Many investors start with a combination of Canadian, U.S., and international equity funds, along with a bond fund for balance.
Set up automatic contributions: automating regular contributions removes the temptation to time the market. It also builds the habit of consistent investing, which is one of the most reliable ways to grow wealth over time.
Review periodically: while passive investing doesn't require constant attention, it's worth checking your portfolio once or twice a year to make sure your asset allocation still matches your goals. Rebalancing — selling a bit of what's grown and buying a bit of what's lagged — helps keep your risk level consistent.
Is passive investing right for you?
Passive investing tends to suit people who prefer a hands-off approach and are comfortable letting their portfolio grow with the market over time. If you value simplicity, low fees, and a long-term perspective, this strategy may align well with your goals.
That said, it's not for everyone. Some investors prefer more control over individual holdings, or they may want the potential — however difficult to achieve consistently — to outperform the market through active management. Others may have specific financial situations that benefit from a more tailored approach.
There's no single right answer, and many investors use a blend of passive and active strategies. The important thing is to choose an approach that matches your risk tolerance, timeline, and financial goals — and that you can stick with through market ups and downs.
