Introduction

Investors often face the choice between passive and active portfolio management. While both strategies have their merits, a passive portfolio foundation can offer significant advantages in terms of cost, performance, and risk management.

Cost Efficiency

Passive portfolios typically have lower fees compared to active portfolios because they do not require the constant buying and selling of securities. This reduction in transaction costs and management fees leads to higher net returns for investors over time.

Consistent Performance

Studies have shown that passive portfolios often outperform their active counterparts, particularly over long periods. This is due to the fact that passive strategies aim to replicate market indices, which have historically provided reliable growth.

Reduced Risk

Passive investing is less susceptible to the risks associated with market timing and stock selection errors. By holding a broad basket of securities, passive portfolios spread risk across many assets, which can mitigate the impact of poor performance from any single investment.

Conclusion

While active management can offer potential for high returns, it comes with increased costs and risks. For many investors, a passive portfolio provides a more stable and cost-effective way to achieve long-term financial goals.

Perpetuity Calculation in Excel

Basic Theory

A perpetuity is a financial instrument that pays a consistent amount over an indefinite period. The formula for calculating the present value (PV) of a perpetuity is:

PV = C / r

Where:

• C = Cash flow per period
• r = Discount rate (interest rate per period)

Procedures

1. Determine the annual cash flow (C).

2. Identify the discount rate (r).

3. Use the perpetuity formula to calculate the present value.

Scenario with Real Data

Consider a perpetuity that pays $1,500 annually with a discount rate of 6%.

    C = $1,500
    r = 6% (or 0.06)

The calculation would be:

PV = 1500 / 0.06
     = $25,000

The present value of this perpetuity is $25,000.

Excel Table Explanation

You can set up an Excel table to perform these calculations:

The formula in the Present Value cell (C2) calculates the present value of the perpetuity.

Alternative Approaches

1. Growing Perpetuity: If the cash flow grows at a constant rate (g), the formula becomes:

PV = C / (r - g)

2. Variable Discount Rate: Adjust the discount rate periodically based on market conditions.