One of the most common pieces of advice for beginning investors is to build a diverse portfolio by investing in an S&P 500 index fund. It's a great tip for most investors because these funds are affordable and provide instant diversification and exposure to some of the strongest companies in the U.S.
But like anything, there are some people for whom this advice won't work. If any of the following scenarios apply to you, that's a sign you should probably stay away from investing in stocks of S&P 500 companies.
1. You don't have an emergency fund
An emergency fund is the first stop on the road to financial freedom. If you don't have one, you shouldn't even be thinking about investing your money. If you have an unplanned expense and all your money is tied up in stocks, you'll have to sell, regardless of the share price at the time. That could mean taking a huge loss.
To avoid this, you need a separate emergency fund kept in a savings account you can access whenever you need. It should contain at least three months of living expenses. Six months is better if you'd like to be conservative, or if you think it'd be difficult for you to find a new job should you lose yours.
Once you have an emergency fund, you can begin to think about investing. At that point, an S&P 500 index fund could be a smart foundation for your portfolio. But if you ever have to use some of your emergency fund on an unplanned expense, make sure you replenish it before you put more money in your investment account.
2. You have high-interest debt
There's no rule that says you can't invest and pay down debt at the same time. But high-interest debt, like credit card debt or payday loans, often costs you more than you'd earn with the best S&P 500 index fund in a year. So it makes sense to pay high-interest debts off before you start investing.
There are a few ways to go about this. You can make the minimum payment on all your credit cards, then put any extra cash toward the balance with the highest interest rate first. When that's paid off, move onto the balance with the next-highest interest rate, and so on, until it's all paid off. Or you could use a balance transfer card -- this temporarily halts the growth of your balance so all your payments go toward the principal.
A personal loan is another option if you have a payday loan or if you want to trade in your credit card debt for a regular monthly payment. Interest rates on personal loans can still be high, especially for those with poor credit. But you won't have to worry about your balance growing over time.
3. You're heavily invested in stocks already
S&P 500 stocks or index funds can offer great returns over the long term, but they're volatile in the short term. So it's not a good idea to invest all of your money in them.
You need to balance out your portfolio with bonds and other safer investments that may not have as much earning potential, but are less prone to extreme value fluctuations.
How much money you should have invested in stocks vs. bonds largely depends on your age and risk tolerance. The general rule of thumb is that the percentage of your portfolio invested in stocks should be 110 minus your age. So a 40-year-old should have 70% of their savings invested in stocks and 30% in bonds.
The scale tips in favor of bonds over time because you'll have more savings and you'll want to protect what you have. Bonds aren't risk-free, but they're a safer choice for seniors and those who will need their money soon.
If none of the scenarios above apply to you, investing in the S&P 500 could be a smart decision for you. You could invest in some S&P 500 company stocks on your own, but if you want to invest in all of them, consider an S&P 500 index fund, or purchasing fractional shares of S&P 500 companies. Both of these enable you to quickly diversify your portfolio without spending thousands of dollars. Weigh all your options to decide which is best for you.