New Year's Day is a time to reflect on the past year and take steps to make the coming year as good as it can be. From a financial standpoint, 2020 has been incredibly challenging for millions of people, and even the promise of a fresh start won't quickly solve many of the money troubles they're facing.
It's therefore understandable that many people have put aside thinking about long-term financial goals in 2020. As important as it is to do things like funding an IRA or making contributions to a workplace retirement account like a 401(k), tough times require difficult choices. Because of that, you won't hear the same advice from me you've seen in past years about getting money into those retirement accounts as soon as you can -- even though that's still a smart thing to do.
For 2021, my recommendation is simpler: Go out and invest in shares of at least one individual stock. It doesn't take much money, but it's a vital part of understanding how the investing world works and how you can take advantage of it to build a financially safe and secure future.
Why owning stocks is more important than ever
Buying individual stocks is something that intimidates many investors. The idea of finding a company you believe in enough to trust that putting your hard-earned money won't cost you everything you invest can be hard for some people to swallow. There are plenty of horror stories of people buying stocks for the first time, only to lose their entire investment.
It's because of that added risk that many investors never buy individual stocks. Instead, they rely on index mutual funds and exchange-traded funds as tools to reach their investment goals. They count on a rising market to provide slow but steady growth, carrying them ever closer to their final targets.
Investors of the caliber of Warren Buffett suggest that many investors should simply choose such an index fund and never look back. But when you look at what those top investors actually do with their money, it's very different. Nearly all of them count on finding individual stocks and putting their cash to work in those businesses.
I have index funds in my portfolio, in part because of the difficulties in investing in individual stocks while writing for The Motley Fool. The idea of owning a small piece of hundreds of different companies is also appealing. But in 2020, something happened that finally got me thinking that index funds aren't the right choice for those who truly want to become better investors.
How Tesla convinced me that index funds are broken
2020 was an incredible year for Tesla (TSLA 4.72%). The Elon Musk-led maker of premium electric vehicles finally broke out of what had been a multiyear rut for shareholders, as the fundamental strength of Tesla's auto business asserted itself. Tesla delivered more vehicles than ever before, and even in the midst of a global pandemic, Musk's vision resonated with people around the world.
That helped the stock more than double in the first two months of the year. After giving back ground during the coronavirus bear market in March, Tesla jumped to a 250% gain by July. News of its 5-for-1 stock split sent that year-to-date rise above 500%, and now, the stock will close the year with gains of around 750%.
Like many investors, I've had trouble coming to grips with Tesla's fundamental value. I understand how bullish shareholders point to the company's innovations for uses in areas far beyond automobiles, but it's hard to put a firm value on technology like artificial intelligence and battery storage.
And so when S&P Dow Jones Indices decided that it would add Tesla to the S&P 500 at its highest valuation ever, I finally lost faith in index funds. Fund shareholders essentially ended up paying almost $700 per share for stock they could've bought under $100 per share less than a year before. I knew it was coming -- but it was still appalling to see ordinary index fund investors pay billions of dollars more for Tesla shares than they should have.
You can be the front-runner
Index funds don't have a choice which stocks they buy, but you do. You can anticipate that a stock like Tesla will get into a big-name index and having funds that track it have to spend billions of dollars in forced stock purchases as a result.
Moreover, you don't have to have huge amounts to invest. Many brokers offer ways to invest as little as $1 to buy fractions of a share of stock. No longer do you have to worry about saving up hundreds or even thousands of dollars just to buy a single share of your favorite company's stock.
Investing in individual stocks does come with some extra work, but it also brings added rewards. Following a company teaches you more about its business and what its prospects are. You'll see successes and failures and understand better what works and what doesn't.
Best of all, you'll take control of your investing. You'll no longer be at the mercy of institutions making decisions for you that affect your finances.
If you've never owned shares of an individual stock before, make 2021 the year you give it a try. Taking the next step toward becoming financially savvy doesn't have to be hard, and it can open the door to opportunities you never believed possible. Happy New Year, and I wish you the best of luck for 2021 and beyond.