A hands-off investor prefers to set an investment portfolio and make only minor adjustments over time. These investors often utilize index funds or target-date funds, which make gradual changes and require minimal oversight.
Key Takeaways
- Hands-off investors adopt a passive approach, setting their asset allocations and rarely altering them.
- They often favor index funds, exchange-traded funds (ETFs), or target-date funds over individual stocks or actively-managed securities.
- Historical data, such as the S&P 500’s performance, shows that passively-managed funds typically outperform active ones over the long term.
- Even passive portfolios require occasional adjustments, especially at significant life milestones like retirement.
Understanding a Hands-off Investor
A hands-off investment strategy suits many retail investors with limited time for routinely monitoring and researching investments. Unlike hands-on, active management that demands constant attention, a passive approach involves setting a diversified portfolio and letting it grow over time.
Active managers believe thorough research can yield higher-than-average returns, but it requires significant effort and time. Meanwhile, many hands-off investors adhere to the indexing philosophy—which holds that a well-diversified portfolio maintained over time is key to building wealth.
One advantage for hands-off investors is the low expense ratios of index funds, compared to active traders who incur higher trading commissions and taxes. This cost-efficiency can lead to better net returns over the long term.
The Benefits and Drawbacks of Being a Hands-off Investor
Studies have consistently shown the benefits of a hands-off approach. For example, between 1997 and 2017, the average equity investor earned 5.29% annually, while the S&P 500 gained 7.20% per year. On a hypothetical $100,000 investment, this could mean earning approximately $120,000 less than a passive investor with a portfolio tied to the S&P 500.
Fixed-income investors also see significant disparities. The average fixed-income investor trailed the Bloomberg U.S. Aggregate Index by 4.54 percentage points annually, resulting in nearly $155,000 less over 20 years.
Special Considerations
Reasons for investor underperformance are varied, but factors like attempts to time the market and behavioral biases such as loss aversion are significant. Staying consistently invested, like an index, is key to taking full advantage of market gains – both in price and reinvested dividends.
Hands-off investors not using target-date funds need to be mindful of periodic rebalancing, especially as they near retirement. Without it, they risk becoming overweight in riskier investments, which could be detrimental during market downturns close to retirement.
In retirement, hands-off investors should shift to a more conservative portfolio, rich in safe assets like cash and high-quality bonds. This may require substantial trading to minimize risk and preserve capital.
Related Terms: index funds, target-date funds, passive management, capital gains, portfolio rebalancing.
