Do stocks or index funds make more sense in your investment portfolio? For some, their belief in index fund investing runs so deep, it's almost like a religion. They'll tell anyone willing to listen to buy index funds. Others sleep better at night knowing their portfolio consists of individual companies they researched in-depth and chose by hand.
Here are some benefits and drawbacks of each to help you determine which option is right for you:
Investing in Stocks
When you buy shares of stock in individual businesses, you become a part owner of the company. That means you get a share of the profits or losses, based on how well the company does.
Suppose the McDonald's Corporation earned $4.5 billion after taxes in profit, and the company's board of directors decided to issue $2,46 billion of that to the company's stockholders in the form of a cash dividend, because 1,010,368,852 shares are outstanding, this works out to $2.44 per share. If you owned 1,000 shares, you'd get $2,440 in cash. If you owned 1,000,000 shares, you'd get $2,440,000 in cash.
Investors who have bought ownership in successful companies in the past have grown wealthier. Imagine if you had become part owner of Amazon, Google, Berkshire Hathaway, Coca-Cola, Nike, Tesla, Target, or Disney when their stock prices were small.
As their profits grow, you benefit based upon the total ownership you hold.
Note
A $10,000 investment in Walmart when the company first issued stock to outside investors in 1970 has now grown to more than $150,000,000 with stock splits and dividends reinvested.
Sometimes companies fail. They may slowly decline or end in a catastrophic meltdown, like Enron. If you own stock in these companies, your shares might be worthless. It's comparable to being a local bakery owner and being forced to shut your doors.
Investing in Index Funds
When you buy an index fund, you are buying a basket of stocks designed to track a certain index, such as the Dow Jones Industrial Average or the . In effect, buying shares of an index fund means you indirectly own stock in dozens, hundreds, or even thousands of different companies.
Someone who invests in an index is saying, "I know I'll miss the Walmarts and McDonald's of the world, but I will also avoid the Enrons and Worldcoms. I want to make money from corporate America by becoming part owner. My only goal is to earn a decent rate of return on my money, so it will grow over time. I don't want to have to read annual reports and 10Ks, and I certainly don't want to master advanced finance and accounting."
Statistically speaking, 50% of stocks must be below average, and 50% of stocks must be above average.It is why so many index fund investors are so passionate about passive index fund investing. They don't have to spend more than a few hours each year looking over their portfolio. Astock investor needs to be familiar with a company's business: its income statement, balance sheet, financial ratios, strategy, management, and more.
Only you and your qualified financial planner can decide which approach is best and most appropriate for your situation. As a general rule, index fund investing is more advantageous than investing in individual stocks, because it keeps costs low, removes the need to constantly study earnings reports from companies, and almost certainly results in being "average," which is far preferable to losing your hard-earned money in a bad investment.
Frequently Asked Questions (FAQs)
What do you look for when picking a stock?
When picking stocks, most investors and traders use some combination of fundamental and technical analysis. Fundamental analysis relies on comparing business fundamentals and stock prices to find valuable stocks at a cheap price. Technical analysis involves studying stock price movement, momentum, and market psychology to determine probabilities for various market scenarios. Many market participants use elements of both methods, but they may specialize in one over the other.
What does it mean to invest in an individual stock?
Investing in individual stock gives you partial ownership of a company. Index investing also gives you partial ownership in companies, but you'll have to look up the fund's portfolio to learn what you own (and in what proportion to your total ETF position). One difference between individual stock ownership and fund ownership is that owning an individual stock may give you the right to vote on company issues (if they are voting shares).
FAQs
Individual stocks may rise and fall, but indexes tend to rise over time. With index funds, you won't get bull returns during a bear market. But you won't lose cash in a single investment that sinks as the market turns skyward, either. And the S&P 500 has posted an average annual return of nearly 10% since 1928.
Is it better to buy S&P 500 or individual stocks? ›
Is Investing in the S&P 500 Less Risky Than Buying a Single Stock? Generally, yes. The S&P 500 is considered well-diversified by sector, which means it includes stocks in all major areas, including technology and consumer discretionary—meaning declines in some sectors may be offset by gains in other sectors.
Should I invest in individual stocks or ETFs? ›
ETFs offer advantages over stocks in two situations. First, when the return from stocks in the sector has a narrow dispersion around the mean, an ETF might be the best choice. Second, if you are unable to gain an advantage through knowledge of the company, an ETF is your best choice.
Should I switch to index funds? ›
Over the long term, index funds have generally outperformed other types of mutual funds. Other benefits of index funds include low fees, tax advantages (they generate less taxable income), and low risk (since they're highly diversified).
What does Warren Buffett think of index funds? ›
In 2020, Buffett said that “for most people, the best thing to do is to own the S&P 500 index fund, adding “People will try to sell you other things because there's more money in it for them if they do.” This no-frills investment strategy is one of the best for ensuring long-term, low-cost gains.
What are 2 cons to investing in index funds? ›
Disadvantages include the lack of downside protection, no choice in index composition, and it cannot beat the market (by definition).
What if I invested $1000 in S&P 500 10 years ago? ›
According to our calculations, a $1000 investment made in February 2014 would be worth $5,971.20, or a gain of 497.12%, as of February 5, 2024, and this return excludes dividends but includes price increases. Compare this to the S&P 500's rally of 178.17% and gold's return of 55.50% over the same time frame.
How much would $1000 invested in the S&P 500 in 1980 be worth today? ›
In 1980, had you invested a mere $1,000 in what went on to become the top-performing stock of S&P 500, then you would be sitting on a cool $1.2 million today.
Why not just invest in S&P 500? ›
The S&P 500 is all US-domiciled companies that over the last ~40 years have accounted for ~50% of all global stocks. By just owning the S&P 500 you miss out on almost half of the global opportunity set which is another ~10,000 public companies.
What is the downside of owning an ETF? ›
ETFs are subject to market fluctuation and the risks of their underlying investments. ETFs are subject to management fees and other expenses. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than their NAV, and are not individually redeemed from the fund.
Passive, or index, ETFs generally track and aim to outperform a benchmark index. They provide access to many companies or investments in one trade, whereas individual stocks provide exposure to a single firm. As such, ETFs remove single-stock risk, or the risk inherent in being exposed to just one company.
Is VOO or VTI better? ›
However, if you know that you'd like a bit more exposure to smaller and medium-sized companies or just want to invest in more stocks overall, VTI is your best bet. VOO, meanwhile, is the better option for investors who want to focus heavily on large cap companies.
Is there a downside to index funds? ›
While indexes may be low cost and diversified, they prevent seizing opportunities elsewhere. Moreover, indexes do not provide protection from market corrections and crashes when an investor has a lot of exposure to stock index funds.
Do billionaires invest in index funds? ›
It's easy to see why S&P 500 index funds are so popular with the billionaire investor class. The S&P 500 has a long history of delivering strong returns, averaging 9% annually over 150 years. In other words, it's hard to find an investment with a better track record than the U.S. stock market.
What is the main disadvantage of index fund? ›
Tracking error may occur in an index fund due to liquidity provisions, index constituent changes, corporate actions etc. This is a major risk in index funds. Index funds do lose out on the expertise of the fund manager and the structured investment approach that an active fund manager brings.
Is it smart to invest in index funds? ›
Index funds are considered one of the smartest types of investments, and for good reason. Investing in index funds has long been considered one of the smartest investment moves you can make. Index funds are affordable, enable diversification, and tend to generate attractive returns over time.
Do index funds beat the market? ›
Index funds seek market-average returns, while active mutual funds try to outperform the market. Active mutual funds typically have higher fees than index funds. Index fund performance is relatively predictable; active mutual fund performance tends to be less so.
