Advanced Diploma of Financial Planning (ADFP) Practice Test

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What is a potential benefit of using passive investment strategies?

Higher potential returns through frequent trading.
Lower transaction costs.
Greater involvement in stock selection.
Daily portfolio assessment.

The correct answer is: Lower transaction costs.

Using passive investment strategies provides the potential benefit of lower transaction costs. This is primarily because passive strategies, such as index investing, typically involve fewer trades than active strategies. Investors following a passive approach usually buy and hold a diversified portfolio that mirrors a market index, which means there are not frequent buying and selling activities that incur costs. Lower transaction costs are advantageous as they can enhance overall returns. High transaction costs can eat into profits, particularly for active strategies that require constant buying and selling of securities to capitalize on market fluctuations. By minimizing these costs, passive investment strategies allow investors to retain a larger portion of their gains over time. In contrast, other options such as higher potential returns through frequent trading or greater involvement in stock selection characterize active investment strategies rather than passive ones. Additionally, daily portfolio assessment is typically associated with active management, where the investor closely monitors the portfolio to make immediate adjustments based on market movements.