Are you looking to make your foray into the stock market but don't know where to start? Maybe you're nervous or even a little intimidated by its apparent complexity?
Don't sweat it. Seriously. It's not nearly as complicated as it seems at first. Making your very first stock pick doesn't have to be a nerve-racking ordeal, either. In fact, the best first pick for any first-time investor is an exceedingly simple one -- just plug into the overall market by stepping into the SPDR S&P 500 ETF Trust (SPY +1.22%).
Instant diversification
It might not be a stock you've heard of before, mostly because it's not a stock at all. Rather, the SPDR S&P 500 ETF Trust is an exchange-traded fund (or ETF), which are just baskets of different securities. In this case, the basket holds all the stocks found within the S&P 500 index. You likely know the S&P 500 as a market barometer, but the S&P 500 fills that role specifically because it reflects the value of the market's biggest and most important stocks.
It's a simple, easy option -- when you buy and sell an ETF, you're buying and selling the basket as a whole rather than trading every single ticker within it. There are several advantages to launching your portfolio with such a simple approach, although two stand out the most.
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Key Data Points
The first of these advantages is instant diversification.
Every investor should understand the importance of diversification. While some stocks do well, others will lag. The prospects for an individual business or entire sector are always changing. As a result, your best bet is to have a well-diversified portfolio with exposure to stocks of varying sizes, sectors, and geographies.
A well-diversified portfolio will never dramatically outperform the broad market, but it won't severely underperform it either. And merely matching the broad market's long-term performance will still leave you with solid, inflation-beating returns.
And the second major advantage of owning index-based ETFs when you have no investing experience is the ability to sidestep the dangerous temptation of trading the popular, hyped up stocks everyone seems to be talking about. Indeed, this advantage is so important it deserves its own stand-alone discussion.
A first-time investor's biggest risk
The financial media industry is an interesting one. It devotes a great deal of time and energy to discussing companies' results and curious corporate developments. Not all of this reporting, however, is necessarily done with investors' best interests in mind. It's largely for infotainment purposes. As Warren Buffett explains it, "most news is noise, not news."
But that doesn't prevent investors from acting on news as it develops, and who can blame them? After all, these headlines can at times be downright intoxicating.
But in the same sense that intoxication leads to hangovers, chasing stocks of companies heavily -- and often bullishly -- discussed by the media has its own risks, and it can often do more harm than good.
In other words, picking individual stocks is difficult enough even if you have experience and know exactly how and where to find ideas for new holdings. Without any experience, it can be downright dangerous. The fact that even professional mutual fund managers struggle to consistently beat the market should tell you everything you need to know about your chances of doing so.
For instance, last year, 60% of large-cap mutual funds offered to U.S. investors underperformed the S&P 500 index they were hoping to beat, according to Standard & Poor's. For the past five years, nearly 79% of these funds didn't keep up with the S&P 500. Over the course of the past 10 years, more than 87% of domestic mutual funds lagged the S&P 500's performance.
If these industry professionals struggle to outperform this benchmark, it's similarly unlikely a new investor without any experience will either -- at least not for very long.
Just be patient
None of this is to suggest you'll never be able to outperform the broad market by picking individual stocks. It is possible to do so. Indeed, smaller investors have something of an advantage over mutual fund managers, in that your portfolio isn't so big that your buying and selling can push stock prices around. With massive amounts of capital to steer, fund managers can do that.
Amassing enough wisdom -- from real-world experience -- to beat the market takes time. You don't want the practice of "learning from my mistakes" to be too costly an affair. You also don't want to wait to put your money to work either, since time in the market does far more heavy lifting for your portfolio than savvy stock-picking for the vast majority of people.
The smartest choice is starting with something simple that doesn't require regular monitoring but can still offer attractive returns. That's the SPDR S&P 500 ETF Trust. You can always add individual stocks to your portfolio in addition to this ETF as you gain more experience.
Just remember to be patient with all of your holdings. Nobody becomes an investing millionaire overnight, no matter how good they are.
