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3 Reasons Not to Invest in Index Funds

By Maurie Backman – Jul 30, 2020 at 8:36AM

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Index funds are often touted as a wise choice for investors. But here's why they may be wrong for you.

Stashing your savings under your mattress won't help you grow wealth. Neither, frankly, will storing that money in the bank, especially given today's interest rates.

If your goal is to put your savings to work, you'll need to invest that money. But investing carries risk and requires research. After all, you don't want to take your hard-earned savings and throw that money into a handful of stocks you know little about.

It's for this reason that index funds have become a popular choice among investors. Index funds are passively managed funds that track the performance of existing indexes. An S&P 500 index fund, for example, will seek to match the performance of the S&P 500 itself.

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Image source: Getty Images.

Index funds offer the benefit of instant diversification with little legwork. Vetting individual stocks, by contrast, requires a lot more effort. Index funds also come with very low fees. But while index funds are a great choice for many investors -- newbies especially -- they may not be the best pick for you. Here's why.

1. You want to beat the market

Index funds are designed to match the stock market's performance. If your goal is to beat the market, then index funds aren't for you. Rather, you'll need to hand-pick individual stocks or mutual funds that are likely to outperform major indexes like the S&P 500.

2. You want control over your investments

When you buy index funds, you don't get a say in what goes into them. An S&P 500 index fund, for example, will give you exposure to the 500 largest stocks by market capitalization. If there are a dozen or so stocks in there you don't like, you're stuck with them.

3. You can diversify on your own

One major benefit of index funds is that by adding them to your portfolio, you automatically get a diverse mix of stocks. But if you feel confident in your ability to research stocks individually from a wide array of market sectors and amass a suitable mix on your own, then there may not be a need for you to fall back on index funds.

What's the right move for you?

Index funds, generally speaking, are a good choice for everyday investors -- people who want to put their money to work, but don't necessarily have a lot of time or patience to research stocks. They're also a good option for investors who are moderately to very risk-averse.

But just because index funds are a good choice for a lot of people doesn't mean they're the right choice for you. If you have the knowledge and skill to assemble your own portfolio, you may find that you get better returns than you would with index funds. And also, there's something to be said about building your own investment mix and taking pride when your efforts prove successful. Or, to put it another way, when it comes to investing, loading up on index funds equates to taking the easy way out. There's absolutely nothing wrong with that, but you may want to aim higher.

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