When it comes to setting up an investment portfolio, you have choices. You can assemble a mix -- ideally, a diverse one -- of individual stocks, or you can fall back on index funds, instead.
Index funds allow you to effectively own a bucket of stocks with a single investment. And while you can choose one fund over the other, you get no say in the specific stocks those funds encompass.
Investing in index funds is a great way to simplify the process, but one thing these funds won't help you do is outperform the broad market. That's because index funds are designed to match the performance of the indexes they're associated with.
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If you want to do better than that, you'll need to choose individual stocks yourself. But if these things apply to you, it's a sign that you're just not ready.
1. You think share price is the most important detail to look at
The price that a company's stock sells at may seem like the single most important piece of information to have on hand. But actually, it's not.
If you're on a budget, then yes, you'll need to focus on companies that have share prices within your reach or buy fractional shares of the companies you want. But just because one company's stock is selling for $150 per share and another is selling for $75 per share, it doesn't mean the first company is the better buy.
A more significant metric to look at is earnings per share. That number can tell you how profitable a company actually is. Its share price alone can't.
2. You let emotions guide your decisions
There may be a company whose product line you adore, but that's not a reason to buy a stock. And if you let the way you feel about different companies dictate which ones you own, you could end up setting yourself up for disaster.
That said, it's definitely a good idea to invest in companies whose business models you understand. And if there's a company whose products you're intimately familiar with, that's a good starting point. But knowing and loving a company's products isn't a good reason to buy it.
3. You're really worried about losing money
There's no such thing as a risk-free investment. Whether you buy index funds or individual stocks, the value of your portfolio could decline substantially during a stock market crash.
But if you're really fearful about taking losses, to the point where it keeps you up at night, then you may not be ready to choose stocks individually. Instead, index funds may be a safer bet.
If you buy stocks and see their value decline, you might panic and sell them at a loss, thinking the problem is with the companies behind those stocks themselves. When index funds lose value, it's because the broad market has lost value.
To be clear, you shouldn't rush to sell index funds when they're down, either. But you may be less inclined to do so when you recognize that whatever has caused your portfolio to decline has also impacted the broad stock market, in general.
Go with what works
Though there are plenty of benefits to choosing your own stocks for your portfolio, you may not be ready to take that step. And that's OK.
There's nothing wrong with relying on index funds while you take the time to boost your investing knowledge and learn to tame your fears and emotions. And remember, you can always stick with index funds for now and graduate to handpicking stocks when the time is right.
