Investing in exchange-traded funds (ETFs) is pretty easy. Most funds track broad market indexes or provide exposure to specific industries. It's simple to understand what the fund is invested in and assess its potential based on past performance. Investing in stocks is harder. You're buying shares of an individual business, and your fortunes will rise and fall based on how investors perceive it.
Still, investing in stocks can pay off because you have the potential to earn far greater returns. You just need to make sure you're really ready before you jump into stock picking. Here are three signs that you've reached this milestone.
1. You have time to manage your investment portfolio
A portfolio full of ETFs doesn't require much management. You can pick your funds in a few minutes based on what stock index or industry you want exposure to. And once you've invested, you don't have to closely monitor your fund's performance. That's because ETFs tend to be far less volatile, and there's less risk of major shifts happening that could affect their performance.
If you want to invest in stocks, you'll need to spend a lot more time researching your options and keeping tabs on the companies you've invested in. A change in leadership, a shift in product strategy, new competitors, and a whole host of other factors could profoundly affect whether it makes sense to remain invested in the business.
2. You know how to diversify
A diversified portfolio significantly reduces your risk. As the old saying goes, you don't want to put all your eggs in one basket.
ETFs provide instant diversification by their very nature. Your money is invested in many different stocks that make up a financial index, or in many different business that are part of a specific industry.
When you buy individual stocks, it's not just as simple as making sure you don't put too much of your money into shares of one company. You also need to make sure you aren't buying all the same types of investments. If you only buy shares in tech companies, for example, then you're too heavily reliant on the success of that field.
3. You have an investment strategy
Building a portfolio full of random stocks is unlikely to pay off for you in the long term. You need a strategy to construct a balanced portfolio that works toward your objectives.
You may want to focus on maximizing income from dividends or buying companies you believe are undervalued, or you may have a different focus altogether. Whatever your specific goal, the important thing is to have a guiding principle to construct your portfolio.
An investment strategy also helps you assess each individual investment. Are you going to focus on dividend yield, the company's price-to-earnings ratio, adjusted earnings, or other metrics? It likely depends on what type of investor you want to be.
Once you've got a solid investment strategy, you can build a diversified portfolio of investments you believe in. So if you have the time and the knowledge, you're ready to get started on stock picking.