Is it better to buy individual stocks or index funds?
Individual stocks offer many more opportunities for tax-loss harvesting than index funds. Estimates put the potential advantage at about 0.5%/year, depending on your tax bracket. If you have individual stocks you can find additional tax management benefits through donations, gifting and dividend yield management.
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.
If you're looking to make a long-term investment, then index funds may be a good option. But if you don't have the time or patience to wait out the market fluctuations, then purchasing individual stocks might be more suitable for your needs.
Index funds are great foundations for many investment portfolios. They're a low-cost way to get diversified exposure to almost any financial market segment. While you can pay a little extra for active management, this isn't necessary and often isn't even profitable.
However, while many of them are regarded as financial wizards, often their investments are utterly pedestrian. In fact, a number of billionaire investors count S&P 500 index funds among their top holdings.
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.
If you're new to investing, you can absolutely start off by buying index funds alone as you learn more about how to choose the right stocks. But as your knowledge grows, you may want to branch out and add different companies to your portfolio that you feel align well with your personal risk tolerance and goals.
While it's true that index funds have historically provided solid returns, it's important to remember that past performance is not a guarantee of future results. Blindly putting all of your savings into index funds without considering other investment options or your personal financial goals could be a mistake.
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.
Investors who buy index funds will not lose all of their investment. That's because they're investments buoyed by hundreds or thousands of underlying securities. As such, they're highly diversified, making it almost impossible for them to reach a value of zero.
What are the negatives of an index fund?
Disadvantages include the lack of downside protection, no choice in index composition, and it cannot beat the market (by definition).
Index Funds Present Lower Risk
The failed company is only a small fraction of the overall fund rather than the entire investment, similar to if you had invested in an individual stock. This inherently makes index funds much lower risk.
- Less Flexibility. While your portfolio is less affected by a declining singular asset, it's not immune to the fluctuations of the larger market, including economic downturns and bear markets. ...
- Moderate Annual Returns. ...
- Fewer Opportunities for Short-Term Growth.
Once you have $1 million in assets, you can look seriously at living entirely off the returns of a portfolio. After all, the S&P 500 alone averages 10% returns per year. Setting aside taxes and down-year investment portfolio management, a $1 million index fund could provide $100,000 annually.
Buffett has consistently recommended an S&P 500 index fund as the best way for most investors to get stock market exposure. The Vanguard S&P 500 ETF tracks about 80% of U.S. stocks by market capitalization.
| Rank | Asset | Average Proportion of Total Wealth |
|---|---|---|
| 1 | Primary and Secondary Homes | 32% |
| 2 | Equities | 18% |
| 3 | Commercial Property | 14% |
| 4 | Bonds | 12% |
The risks are too great with individual stocks
Financial pros like Benz urge investors to build broadly diversified portfolios for a reason: While the overall historical trajectory of the stock market has trended upward, any individual stock has a chance to decline sharply in price and destroy your portfolio's returns.
Research: 89% of fund managers fail to beat the market
According to this report, 88.99% of large-cap US funds have underperformed the S&P500 index over ten years. As a whole, 78–97% of actively managed stock funds failed to beat the indexes they were benchmarked against over ten years.
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.
| Pros | Cons |
|---|---|
| Lower fees than actively managed funds | Little downside protection (especially during bear markets) |
| Lower risk than actively managed funds | Lower return potential |
| Hands-off; little research/knowledge necessary | No control over fund composition |
How long should you keep money in index fund?
Ideally, you should stay invested in equity index funds for the long run, i.e., at least 7 years. That is because investing in any equity instrument for the short-term is fraught with risks. And as we saw, the chances of getting positive returns improve when you give time to your investments.
Are Index Funds Safe Long-Term? The short answer is yes: index funds are still safe in the long term. Only the right index funds are safe. There may be some on the market that you want to avoid.
Investing in funds, such as exchange-traded funds and low-cost index funds, is often less risky than investing in individual stocks — something that might be especially attractive during a recession.
The addition of too many funds simply creates an expensive index fund. This notion is based on the fact that having too many funds negates the impact that any single fund can have on performance, while the expense ratios of multiple funds generally add up to a number that is greater than average.
It might actually lead to unwanted losses. Investors that only invest in the S&P 500 leave themselves exposed to numerous pitfalls: Investing only in the S&P 500 does not provide the broad diversification that minimizes risk. Economic downturns and bear markets can still deliver large losses.
