Many investing decisions come with a clear best answer that will help you get the most from your money. But not every decision is so cut and dried. Often, the difference between two options isn't enough to justify the time you'll spend agonizing over which option to choose.
Although you'll always find someone willing to argue about any investing "rule," some statements are hard to dispute. Among others:
- Although the bear market has turned many people off to the stock market, stocks have historically done a better job than bonds and cash at helping people make fortunes.
- For those saving for retirement, using tax-advantaged savings vehicles like IRAs and employer-sponsored retirement plans give you benefits you can't match anywhere else.
- The earlier you start investing, the easier it is to reach your goals. With more years of compound returns on your side, you can start out with a lot less money and still end up better off in the long run.
But many other investing decisions draw good arguments from both sides. Consider the following tough calls.
Index funds vs. active funds
The debate about indexing continues to rage. Although numerous studies over the years have shown that most actively managed mutual funds underperform their index counterparts, many fund investors aren't satisfied with market returns and want to find a fund that can beat the market.
In particular, opponents point to the most obvious failure of index funds: their slavish devotion to market losers. The S&P 500, for example, continues to include shares of fallen giants like AIG (NYSE: AIG) and General Motors (NYSE: GM), both of which have fallen more than 90% in the past year. And while it dropped companies like Fannie Mae (NYSE: FNM) and Freddie Mac long after they had suffered huge losses, the index often adds new companies only after their stocks have risen sharply. Google (Nasdaq: GOOG), for instance, was added to the S&P 500 in March 2006 at a price of $390 per share -- just below its current price, and nearly four times its IPO price just two years before.
Meanwhile, some fund managers have great track records. Yet many question whether their successes are sustainable -- especially in light of the failures of renowned managers to anticipate the current bear market.
It's true that active funds tend to cost more than index funds, putting you at an immediate disadvantage. If you choose the right active funds, however, you can minimize that disadvantage while still keeping open the possibility of market-beating performance.
Picking stocks within an industry
Often, you'll identify a strong sector of the economy but be unsure which particular stock to buy. For instance, you might think that the retail sector has gotten beaten down so far that it's due for a comeback, but have no particular insight into whether an old favorite like Gap (NYSE: GPS) can recover its footing better than a younger retailer like American Eagle Outfitters (NYSE: AEO).
You can always take the time to do stock-specific research and analysis to hammer out which stocks are likely to do best. But with sector exchange-traded funds (ETFs) such as SPDR S&P Retail, you get full exposure to those traditional retailers, along with other companies with different focuses, such as online travel site priceline.com (Nasdaq: PCLN).
Of course, if you have a strong belief that one company stands head and shoulders above the rest, you should pick that stock. But more frequently, you'll have a general sense about an industry. In that case, it usually won't make a huge difference whether you choose a few top stocks or go with a diversified sector ETF.
Save your strength
As with many things, you have to know how to pick your battles in investing. If you don't waste time on close calls that aren't that important, you can conserve your strength for those decisions that do matter.
For more answers on important investing decisions, read about:
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