The COVID-19 crisis has sent the stock market on a wild ride these past few weeks, so much so that in late March, it plunged into bear market territory for the first time in over a decade. And with so much uncertainty due to COVID-19, it's hard to predict when the market will calm down and fully recover its losses.
For some people, ongoing volatility is enough to make them hide under the covers and stay out of the stock market, but as many seasoned investors know, a down market offers a key opportunity to load up on quality stocks and index funds at a discount. The question is: Are individual stocks a better buy at this time, or should you favor index funds for your portfolio?
It's all about diversification
Index funds, as the name implies, are passively managed, and what they do is aim to track the performance of existing indexes. For example, an S&P 500 index fund's value will correlate to how the S&P 500 is faring.
Index funds are a popular choice for investors for a number of reasons. First, they take much of the guesswork out of investing. Vetting individual stocks takes time. You need to understand their business model, assess their cash flow, and evaluate their earnings potential. Index funds don't require the same amount of legwork, because again, you're simply following existing market indexes that have already been established.
Another benefit of index funds is instant diversification. Rather than buy a single stock, an index fund effectively puts your money into a basket of stocks. That's useful during periods when some market segments may be more prone to declines than others.
Here's another way to look at it: If you buy an S&P 500 index fund, you're effectively investing in the 500 largest companies listed on U.S. stock exchanges. If you buy shares of a single stock, you're putting all of your eggs in that one basket. If that stock tumbles, your portfolio value declines. But if, say, 20 S&P 500 stocks take a hit, you have another 480 that may hold up, thereby not impacting your portfolio to the same extreme.
What's the best choice for you?
If you're not sure whether to favor index funds or individual stocks in the coming weeks, think about your desire and ability to vet individual companies coupled with your appetite for risk. Buying individual stocks gives you more control over your portfolio. That's a good thing if you're confident in your ability to evaluate stocks and want to put in the time. It's a bad thing if the thought of doing so is overwhelming, and if you happen to choose a stock that tanks after you buy it.
Of course, without a crystal ball, there's no way to know whether a portfolio of individual stocks that you assemble in the coming weeks will outperform the index funds you might choose instead. And to be clear, there's no right or wrong answer when it comes to deciding where to put your money. But at the end of the day, it pays to choose a strategy you feel comfortable with -- one that won't lead to you constantly second-guess your portfolio and make frequent changes to it. Doing so increases your chances of panic selling, and that's a good way to lose money in the stock market, especially during periods when it's prone to massive swings.