Index funds have recently become super fashionable because they allow even the newbie investors to get themselves exposed to the stock market and grow their money. Plus, Warren Buffet keeps promoting them now and then too, which makes them look even better.
Index funds are basically a basket of stocks that imitates the composition and performance of a stock market index such as the S&P 500 or Russell 2000.
These index funds are popular among beginner investors because it removes you as an investor from the driver’s seat and allows you to track the market without really knowing much about investing.
While index funds provide several benefits like low fees, tax advantage, diversified portfolio, etc., and can be considered a really great starting point in your investment journey, we’re of the opinion that individual stocks are still better than index funds.
In this blog, we’ll be telling you why we prefer to invest in individual stocks as opposed to index funds and how you can do that too without sacrificing your time or risking more than you can afford.
Index Funds vs Stocks
Index funds are all the rage these days thanks to the modern portfolio theory that suggests that markets are efficient and that a security’s price includes all the available information.
Index fund advocates all over the internet argue that active management of your portfolio is useless, and you’d be better off simply buying an index and going along for the ride. But we’re here to say “Nope!”.
While index funds can be a great starting point for newbies in the stock market. After all, it provides you several benefits apart from the convenience of growing your money without active management. But you may be missing out on some things, and some of them are not even about money.
Whether you’re a beginner or an experienced investor, we prefer individual stocks over index funds, and we have exactly 4 reasons why. So let’s dive in and see what are the reasons why between index funds vs stocks, we choose stocks.
4 Reasons Why You Should Avoid Index Funds
If you look on the internet about index funds vs stocks, the popular opinion is that index funds are better than individual stocks, which is contrary to what we’re saying. But we have some legit reasons why we have an unpopular opinion. Let’s go through them.
1. You Don’t Have Downside Protection in an Index Fund
With an index fund, you won’t have downside protection. Also, some individual stocks actually way outperform the market when it comes to recovering from a crash. For example, it took the S&P 500 6 years to recover from the 2008 housing market crash, while some stocks like AMZN and AAPL recovered in 2009 itself.
There’s obviously no denying that the stock market can be very very volatile. Investing in an index fund, like the ones that track the S&P 500, will give you an upside when the markets are doing well but also leaves you completely vulnerable to the downside.
You can choose to hedge your exposure to the index by shorting the index or buying some puts against it, but because these moves are the exact opposite of each other, using them together defeats the whole purpose of investing that is to make money.
Also, how many investors, especially beginners, know how to hedge their positions properly. Doing it wrong can result in a loss on both sides.
With the stocks, you can actually buy more as the price dips, given it’s a good stock like AAPL and AMZN, and enjoy the profits later while being patient and not panicking over each and every bump in the road. When it comes to stocks, patience is a profitable virtue.
2. No Control Over Your Holdings
Indexes are set portfolios. When you buy an index fund, you have no control over individual holdings in your portfolio.
You may have specific companies that you absolutely love and would like to own, but there are also companies that you probably had a bad experience with or just don’t wanna own.
In such cases, investing in an index fund is like buying those wholesale surprise Christmas bag of toys that comes with like 30 different items, where you like some of them while others are just crap.
Also, keep in mind that by investing in a company, you are making a statement. You’re indirectly supporting that company’s views, social responsibility and morals.
So for those who see investing in a company as more than just a way to make money, buying into an index fund can mean supporting all the companies that are constituents in the index.
3. “Stocks Are Too Risky” is a Myth
This is the reason why many ‘experts’ recommend people to just buy into an index fund because individual stocks seem too risky.
Many people also have the same myth that stocks are only for people with high risk appetite because they’ve heard those horror stories of people losing thousands of dollars in stocks.
The actual reason why people lose money in the stock market is that either they lack the knowledge and follow some guru’s advice to make money. Or they do trading in the markets in the hopes of making a lot of money in a small amount of time, taking more than required risk.
Now, some of you might be thinking “aren’t trading and investing the same thing?” And the answer is – absolutely not. In fact, they can be called two entirely different professions.
Trading the markets is trying to make a quick profit on the market’s ups and downs, which is always high risk because, as you know, the financial markets are very volatile.
Investing is typically lower risk because we’re not betting that the stock price will go up or down today or tomorrow. Investing is about putting your money in assets that will increase in the long-term.
The only people that can actually make money by trading and managing these index funds are the ones who put millions of dollars into the market and are glued to their screen all day.
Now, we are not trying to say that trading is right or wrong, but most people often get into trading with the hope of getting rich quickly, which is why most of them end up taking high-risk trades that eventually lead to a loss of money.
Investing, on the other hand, is intended to utilize the current surplus of cash and using it to build more wealth.
4. Your Investments Are Not Unique to Your Risk Tolerance and Financial Goals
The biggest and most important reason why we prefer individual stocks over index funds is that when you invest in an index fund, you won’t be able to create investment strategies based on your own unique financial situation, your unique risk tolerance, and your personal financial goals.
Investing is a very personal process. What works for me might never work for you because our willingness and ability to take a risk are not the same, we probably don’t belong to the same age group, our living expenses are different from each other, and so should be our investment strategies.
You won’t be able to do that with an index fund because you’ll have to blindly follow whatever the index tracks. And while an index fund could give you diversification, it may not be optimal for your needs and financial goals.
Do you need dividend-paying fixed income? Can you wait out the growth phase of a promising value stock? Are you approaching retirement and need more stability? With an index fund, you won’t have a say on any of that.
Also, it is a misconception that creating and managing your own portfolio is very hard. Because once you get the fundamentals down, you can just devote one hour per week towards managing your portfolio and still do very well.
It won’t take it all that long to monitor your very own customized portfolio that is not locked in a wealth manager’s fund and consists of a ton of random stuff.
That’s it about index funds vs stocks. Now, if you’re interested in learning the exact steps that you should take to invest in individual stocks that outperform any index fund without being stuck to your screen all day, then you can check out the free masterclass here: learn.investdiva.com/now-a.