Investing in the stock is not for the faint of heart. Stocks are very volatile, and seeing your portfolio value go up and down during periods of turbulence is enough to break even the most experienced investors into a full body sweat. But if you’re particularly picky about investing, there’s one option you might want to explore: index funds.
Why index funds work for nervous investors
When you buy individual stocks, a lot is at stake – and a lot of legwork is involved. You need to look for a number of important things, including:
That is a particularly high order if you are new to investing. But even if you have been doing it for a while, buying individual stocks requires you to make difficult decisions that can backfiring. And so index funds can be a better choice if you are the nervous type when it comes to investing.
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With index funds you do not buy or pay individual companies. After all, you are buying a passively managed fund that follows a specific index to which it is tied.
For example in S&P 500 index fund will aim to match the performance of the S&P 500, which is an index made up of the 500 largest trading companies by market capitalization. That’s a very good measure of how the stock market performs overall.
It should make you less nervous as an investor to invest in index funds, although it is possible for them to decrease in value, which generally only happens when the whole market takes a hit (especially when we talk about S&P 500 index funds). Or to put it another way, with index funds, you will not end up choosing one specific bad investment. After all, you will win if the broader market gains, and if stocks are down, your portfolio will be the same – but it will probably be no less than the market.
Another advantage of index funds is that the performance of individual companies is less important. If you buy a specific stock and their earnings report does not meet expectations, that stock may drop. But if that single stock is just one of many in an index fund that you hold, it will not have the same impact on your portfolio.
Index funds also offer built-in diversification, as you re-buy a basket of stocks, as opposed to individual stocks. If you are worried about losing money in the stock market, index funds can reduce those worries to some degree, because if a single company or market segment takes a hit, it may not affect you that much.
Is there a disadvantage to index funds?
One thing you need to know about index funds is that they are not designed to beat the market. If you invest in actively managing mutual funds – those with skilled fund managers at the helm – you can defeat the market. But many asset management funds repeatedly miss out on their benchmarks, and in return for that stock-taking approach, you pay substantial fees – up to 10 times more than what you would pay to invest in index funds.
However, if you want to do better than the broader market, an actively managed scientific fund may be a better choice. In this way, you place your investment decisions in the hands of people who analyze stocks for a living.
Another disadvantage of index funds is that you do not get any say in your investments. If there is a specific business that you do not like, you can invest in it anyway. But if you’re the type who’s nervous about choosing stocks in the first place, you may not want to a saying in your investments. After all, you can be more comfortable if that decision is made for you.
Push past your fear
Index funds can not prevent you from taking losses in your portfolio, but they can will gives you the peace of mind that comes with knowing that you are investing in the broader market. If the idea of choosing stocks scares you, try to focus on index funds. If anything, it will take a load off your shoulders on the road to building wealth.
