Many investors rely on index funds to build their portfolios, and for good reason. The beauty of index funds is that they take the guesswork out of investing. Rather than have to thoroughly research companies, you can instead rely on the performance of broad market indexes, like the S&P 500, to deliver results.
Index funds definitely have their limitations, though. For one thing, their goal is to match the performance of the benchmarks they're tied to, not beat it. An S&P 500 index fund, for example, will aim to do as well as the S&P 500 itself. But if you want to outperform that index, you'll need to choose specific stocks to buy.
Also, with index funds, you get no say in how your money is invested. If there are specific S&P 500 companies you're not a fan of but you buy S&P 500 index funds, you're stuck owning them, even if indirectly.
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It's for this reason that you may want to hand-pick your own stocks rather than fall back on index funds. But are you ready to take that leap? Here are a few signs that you're up for the challenge.
1. You understand what to look for
There are different factors that make a company a good buy. But hearing its name on the news a lot isn't necessarily one of them. Rather, you should be looking at factors like:
- Cash flow
- Debt
- Competitive advantages
- Management
- Innovation
As long as you understand how to vet a stock, there's no reason not to choose the ones you feel best align with your investing strategy and goals.
2. You know the risks involved
Buying individual stocks can be riskier than falling back on index funds. That's because you're relying on the performance of a specific company rather than a broad index that comprises many different companies.
As long as you understand the risks in buying individual stocks, and they align with your personal comfort level, there's no reason not to move forward. But make sure you recognize that owning individual stocks could mean seeing more substantial losses at times.
3. You're prepared to diversify
Index funds make it easy to maintain a diverse portfolio. If you're going to shift toward individual stocks, make sure you're willing to load up on companies across a range of market segments. You may, for example, opt to buy some tech stocks, but also some bank stocks, auto stocks, healthcare stocks, and energy stocks.
Are you ready to take control of your portfolio?
Choosing individual companies to invest in could help you beat the market and enjoy great success. And if these signs apply to you, you may be ready to take that leap.
But keep in mind that there's nothing wrong with owning index funds as well as individual stocks. In fact, doing so could buy you some protection during periods of market turbulence, while still setting you up to outpace the broad market's performance. And so if that's the route you choose to take, you could end up doing quite well for yourself.
