Q: I want to start investing in stocks, but wonder if I would be better off sticking to mutual funds. How can I tell if I'm ready?
Warren Buffett has said that most investors are better off investing in low-cost index funds than buying individual stocks. And it makes sense -- index funds are guaranteed to match the performance of the underlying index over time, and research has shown that most individual investors significantly underperform the market.
I believe there are three traits investors need before buying individual stocks: time, knowledge, and desire.
You need time, because properly researching and comparing stocks, as well as monitoring your stocks on an ongoing basis, takes a significant amount of effort. If you don't have at least a couple hours per week to dedicate to your investing, you probably shouldn't buy individual stocks.
You need knowledge to do your research and to monitor your investments correctly. This means learning how to read stock quotes, how to calculate and interpret some basic investing metrics, and how to read a company's financial statements.
You also need the desire to invest independently. Most people are completely content with setting their 401(k) funds or contributing to mutual funds.
Finally, I'll add that you need sufficient capital in order to create a properly diversified portfolio of at least 10 or so stocks. It's not a good idea to invest in just one or two stocks, and commissions can make it impractical to invest a small amount of money in several stocks. Alternatively, if you don't have a lot of money, you can put the bulk of your money in funds and add individual stocks over time.
