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I Mostly Buy Index Funds and ETFs For These 3 Reasons

By Diane Mtetwa – Updated Aug 18, 2020 at 4:22PM

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Using index funds as the core of your portfolio can be a great way to meet your goals while saving time and money.

I worked as a financial advisor for 12 years. As an industry professional, people are always surprised by my investment choices. My friends have frequently asked me which stocks I like best, and my answer is usually the same.

I don't really invest in individual stocks -- I'm primarily a passive investor.

Of course, I have the know-how needed to buy individual stocks from my work experience. But for the most part, I choose not to.

Helping other people invest has taught me a valuable lesson: It is incredibly hard to beat an exchange over the long run.

Of course, stocks can be a great way to build wealth. I know that if I want my investment accounts to grow significantly over time, investing in stocks is a must. For me personally, I've found that the best way to get exposure to stocks is through passive investments, like ETFs and index funds.

Investing guru Warren Buffett believes this to be true, as well, and he has said this many times over the years. In a 2017 interview with CNBC On the Money, he stated: "The thing that makes the most sense practically all of the time... is to consistently buy an S&P 500 low-cost index fund."

Here are three key reasons why index funds and ETFs are my asset classes of choice.

Stock prices changing on an exchange on a computer screen.

Image source: Getty Images.

1. Time  

Before I decide to purchase any stock, I make sure that I fully understand the company and the business. This initial research can be very time-consuming, but it's necessary to make sure the stock's worth holding for the long term.

And in order to be successful, this is a continual process. I need to maintain my research for any industries or companies that I own, to assess whether they still match my investment objectives. If a company I own has products that fall out of favor, or if a company's industry is becoming obsolete, I might want to sell.

With ETFs and index funds, however, you get access to all stocks and other assets held in the fund. They are the ultimate definition of "set and forget" investments. The only time that I have to revisit these funds is if there's a change in my personal financial goals, or if I need to rebalance my portfolio. 

2. Diversification

Investing in stocks can be one of the best ways to grow your portfolio, but it's also one of the riskiest. To reduce that risk, you'll need to diversify your holdings.

Researching and picking enough stocks to ensure proper diversification can be time-consuming. Depending on your investing budget, achieving a well-diversified portfolio with individual stocks may also be hard. When you buy an index fund or ETF, you automatically get some level of diversification at a low cost.

3. It's expensive

Buying individual stocks can get expensive. The need for diversification tells me that I don't want to put all of my eggs into one or a few baskets. Instead, I want to own many different stocks across different industries and asset classes.

The more stocks I add to my portfolio, the more I need in investable assets. This means that the amount of money that I would need to buy a few shares of just one stock could cost the same amount of money -- or more -- than buying a few shares of an already diversified ETF or index fund. 

The role of stocks in my portfolio

Now, I understand that index funds and ETFs aren't as sexy as that up-and-coming technology company! For the part of me that wants to have a chance at buying the next Apple, I do hold a collection of stocks. It just makes up a small portion of my overall portfolio. My index funds and ETFs are the core of my investing strategy and make up the biggest part of my portfolio, while my stocks are more speculative investments.

If my stock investments do well, great! I end up earning more than I expected. And if these stocks perform badly, I'm not putting myself in a position where I can't reach my investing goals.

The number of stocks I own varies based on market conditions. For example, I'm more likely to buy stocks in an investment climate where more opportunities exist. At the beginning of the COVID-19 pandemic, the stock market experienced a sharp drop. This meant that many stocks were now trading at a discount. Knowing I could buy stocks at a fraction of the price they were previously trading at gave me a desire to hunt for good opportunities.

Diane Mtetwa has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has a disclosure policy.

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