Advanced Diploma of Financial Planning (ADFP) Practice Test

Which of the following statements best describes passive investment management?

1. It requires constant monitoring of the market

2. It aims to replicate the performance of a specific index

3. It involves buying and selling based on market timing

4. It focuses exclusively on stocks

The correct answer is: It aims to replicate the performance of a specific index

Passive investment management is characterized by its objective to replicate the performance of a specific index, rather than trying to outperform it. This approach is grounded in the belief that, over the long term, markets are efficient and that it's challenging to consistently achieve higher returns than what the market offers. By mirroring an index, such as the S&P 500, passive management allows investors to gain exposure to a broad array of securities without the need for frequent trading or market timing strategies. This method typically involves lower management fees than active investment strategies, as it does not require extensive research and constant adjustments to a portfolio based on market fluctuations. Passive management is often achieved through index funds or exchange-traded funds (ETFs) that track the performance of specific indices. Thus, focusing on replicating an index rather than managing investments frequently or making tactical decisions is the core principle of passive investment management.