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.
