Index funds take the guesswork out of investing, but you're by no means limited to them.
For some people, the idea of building an investment portfolio is overwhelmingly daunting. And if you're new to investing, or aren't well-versed in vetting stocks, that's understandable. Thankfully, there's a good solution for those who are nervous about hand-picking stocks, or for those who would simply rather take a more hands-off approaching to investing -- buying index funds.
Index funds are passively managed funds that aim to match the performance of the benchmarks they're associated with. If you buy S&P 500 index funds, for example, those funds will aim to do as well as the S&P 500 itself.
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There are many benefits to buying index funds and holding them for many years. But should they be your only investment? That depends.
A world of pros, but also, some cons
The great thing about index funds is that they take the guesswork out of investing. Rather than spend time researching different companies, you could instead load up on index funds in your portfolio and then effectively sit back and do nothing.
Index funds can also lend to instant diversification. And that's a good thing for your portfolio to have. It can help you weather stock market turbulence and set you up for long-term gains.
But index funds have their drawbacks, too. For one thing, when you buy index funds, you get no say in what they're comprised of.
Furthermore, index funds won't let you beat the broad market. If you're fine with the idea of matching the market's performance, then this isn't a problem. But if your goal is to outpace the market, index funds won't get you there.
And that leads back to our question -- should index funds be your only investment? Well, if you really don't like the idea of hand-picking stocks or are extremely worried about making a series of bad calls, then there's truly nothing wrong with relying solely on index funds to grow wealth over time.
On the other hand, if you're up to the challenging of choosing some of your own stocks, you can assemble a solid portfolio that consists partly of index funds and partly of the companies you identify as winners. That way, you get the relative stability and consistency of index funds, but you also get a chance to beat the market with the individual companies you land on.
If you're new to investing, you can absolutely start off by buying index funds alone as you learn more about how to choose the right stocks. But as your knowledge grows, you may want to branch out and add different companies to your portfolio that you feel align well with your personal risk tolerance and goals.
In fact, even if you reach the point where choosing stocks becomes second nature to you, you might still opt to hold onto index funds and add more to your portfolio. And if you have a 401(k) plan, which, unfortunately, generally won't let you invest in individual stocks, you should definitely consider loading up on index funds to avoid the heftier fees that tend to come with other employer retirement plan investments.
FAQs
Loading up on index is a great way to build a diverse portfolio. While you can fall back on index funds, you may want to branch out beyond them for one big reason.
Is it okay to only invest in index funds? ›
Investing legend Warren Buffett has said that the average investor need only invest in a broad stock market index to be properly diversified. However, you can easily customize your fund mix if you want additional exposure to specific markets in your portfolio.
Is investing in an index fund enough? ›
If you're looking to make a long-term investment, then index funds may be a good option. But if you don't have the time or patience to wait out the market fluctuations, then purchasing individual stocks might be more suitable for your needs.
How much of my investments should be in index funds? ›
The 90/10 rule in investing is a comment made by Warren Buffett regarding asset allocation. The rule stipulates investing 90% of one's investment capital toward low-cost stock-based index funds and the remainder 10% to short-term government bonds.
Should I invest in single stocks or index funds? ›
Investing in an individual stock can deliver very high returns, and you won't be taxed on any capital gains until you sell, in a taxable account. A single stock can potentially return a lot more than an ETF, where you receive the weighted average performance of the holdings.
Why don t the rich invest in index funds? ›
One of the main reasons is that some investors believe they can outperform the market by actively selecting individual stocks or actively managed funds. While this is possible, it is not easy, and many studies have shown that the majority of active investors fail to beat the market consistently over the long term.
Why not just invest in S&P 500? ›
The S&P 500 is all US-domiciled companies that over the last ~40 years have accounted for ~50% of all global stocks. By just owning the S&P 500 you miss out on almost half of the global opportunity set which is another ~10,000 public companies.
Is there a downside to index funds? ›
While indexes may be low cost and diversified, they prevent seizing opportunities elsewhere. Moreover, indexes do not provide protection from market corrections and crashes when an investor has a lot of exposure to stock index funds.
Is it smart to put all your money in an index fund? ›
Are Index Funds Good Investments? Index funds are very popular among investors. They offer a simple, no-fuss way to gain exposure to a broad, diversified portfolio at a low cost for the investor. They are passively managed investments, and for this reason, they often have low expense costs.
Are index funds safe during a recession? ›
The important thing to remember about index funds is that they should be long-term holds. This means that a short-term recession should not affect your investments.
Warren Buffet's 2013 letter explains the 90/10 rule—put 90% of assets in S&P 500 index funds and the other 10% in short-term government bonds.
What is the 4% rule for index funds? ›
The 4% rule says people should withdraw 4% of their retirement funds in the first year after retiring and take that dollar amount, adjusted for inflation, every year after. The rule seeks to establish a steady and safe income stream that will meet a retiree's current and future financial needs.
What did Warren Buffett tell his wife to invest in? ›
The percentage may shock you.
Part of the cash would go directly to his wife and part to a trustee. He told the trustee to put 10% of the cash in short-term government bonds and 90% in a low-cost S&P 500 index fund.
Is it safe to only invest in index funds? ›
Lower risk: Because they're diversified, investing in an index fund is lower risk than owning a few individual stocks. That doesn't mean you can't lose money or that they're as safe as a CD, for example, but the index will usually fluctuate a lot less than an individual stock.
Is it better to invest in multiple index funds or just one? ›
Diversification is an important investment strategy that can help reduce overall risk and increase potential returns. Yes, it can make sense to invest in multiple index funds as part of a diversified investment portfolio.
Do index funds actually own stocks? ›
Every index fund tracks a market index. Fund managers create portfolios that mirror the makeup of their target index with a goal of duplicating its performance. For example, an S&P 500 index fund would own the stocks included in the index and attempt to match the overall performance of the S&P 500.
Should I just put my money in an index fund? ›
Index funds can be an excellent option for beginners stepping into the investment world. They are a simple, cost-effective way to hold a broad range of stocks or bonds that mimic a specific benchmark index, meaning they are diversified.
Are index funds still the best way to invest? ›
Index funds offer low costs, broad diversification, and attractive returns, making them a good option for investors interested in a simple, low-cost investment. Rather than hand-selecting investments, index fund managers buy all (or a sample of) the securities in an underlying index.
How much would $10,000 invest in the S&P 500? ›
Assuming an average annual return rate of about 10% (a typical historical average), a $10,000 investment in the S&P 500 could potentially grow to approximately $25,937 over 10 years.
Are index funds completely safe? ›
Safety in Index Funds? Perhaps because of their popularity, index funds are sometimes perceived to be the safest way to invest. The benefits above are not to be ignored, but index funds are not necessarily safe investments. Put another way, they're not substantially safer or riskier than any other type of mutual fund.
