You've probably heard time and time again that it's important to diversify your portfolio. The reason? Holding a diverse mix of stocks can help you capitalize on broad market gains.
At the same time, diversifying your holdings can help you avoid major losses during periods of stock market volatility. Similarly, diversifying protects you in the event a specific market segment takes a beating. Say regulatory changes come through that specifically impact bank stocks. If you own a disproportionate number of those, your portfolio could take a huge hit.
Of course, the problem with diversifying is that it could, in theory, require more legwork. After all, it's easier to research and buy two or three stocks than it is to assemble a portfolio of a dozen different companies or more. But if you're eager to diversify without putting in a ton of time and effort, here's a good solution for you -- index funds.
Why index funds really pay
Index funds are, in a nutshell, a hands-off investor's dream. With index funds, you don't have to spend hours researching companies one by one. Instead, a single investment will buy you a bucket of stocks that lend to instant diversification.
Index funds track existing market indexes. You may have heard of the S&P 500 index, for example. Well, S&P 500 index funds have the goal of matching the performance of the S&P 500 itself. If you buy S&P 500 index funds, you'll effectively be invested in 500 different companies -- but without having to make 500 unique transactions.
Furthermore, index funds are a good investment option if you don't want to continuously have to tweak your portfolio through the years (though checking in quarterly is definitely advised). Since the performance of index funds is tied to the broad market, there's really not much for you to do other than sit back and see how they perform.
Now, one drawback of index funds is that they won't help you beat the market. If you want your portfolio to outperform the S&P 500, for example, then S&P 500 index funds won't do that trick. But if you're content with the idea of matching the broad market's performance, index funds are a good bet.
Of course, index funds also don't let you choose your investments. You may get stuck with some companies in your portfolio that you're just not a fan of. For example, some people really don't like tobacco companies, but if you buy S&P 500 index funds, you might get stuck investing in that industry whether you want to or not. But if you favor convenience over control, then index funds are a good choice for you.
No matter your age, income level, or risk tolerance, having a diverse portfolio is crucial for both maximizing growth and mitigating losses through the years. Index funds let you accomplish that goal, so they're worth considering if you want a truly easy way to diversify your holdings without taking on undue risk.