Use a stress-free investing strategy in funds and still beat your goals
Turn to your favorite investing channel or click through to just about any financial blog and all you hear is stocks, stocks, stocks.
Everyone is trying to find that next stock that will make them rich.
But is that the best way to invest? Is investing in mutual funds and exchange traded funds (ETFs) a better and easier strategy?
What are the factors that make funds a better investment versus stocks?
Individual Stocks Are More Volatile
Yes, individual stocks have a higher potential return. You also have to pick the right ones to get those amazing returns. Invest in the wrong stock and you'll seriously underperform the market.
General Electric’s share price has declined 43% in 2017, while the S&P 500 gained 20% in the same 12-month window. A $1,000 investment in GE would only be worth $670 while investing in an S&P 500 index fund would have a market value near $1,200.
If GE is the bulk of your portfolio, you would be missing out on the historic gains the broad market has enjoyed this year.
To avoid this volatility and uncertainty, I primarily invest in mutual funds and ETFs that hold positions in as little as 70 companies or as many as 2,000 depending on the fund’s investment strategy. By holding numerous stocks, the fund automatically diversifies and the bad performance of one stock will not necessarily drag on the performance of the fund.
Your funds might own General Electric, but if it’s only a small portion of the total portfolio allocation, the positive performance of the other holdings can hopefully absorb GE’s 43% decline.
If you can’t stomach the roller coaster volatility of stocks and don’t know how to build a diversified stock portfolio, you should invest in mutual funds and ETFs instead. Funds have their bad days too, but the gains and losses are usually less extreme. To minimize your volatility as much as possible, many investors like investing in index mutual funds because they try to mimic (not outperform) their benchmark index.
It’s extremely hard to beat the market and funds do a good job of producing consistent, positive returns without an excessive amount of risk.
You will still need to choose several different funds to diversify your portfolio and a diversified portfolio helps ensure you own both winners and losers, instead of only losers.
Anybody Can Afford an ETF
A single share of Amazon stock currently costs about $1,100. If you can only invest $100 a month, you have to wait an entire year to save up $1,100 to buy Amazon. If the share price continues to climb while you save, you may never be able to afford to buy a share of Amazon.
I don’t know about you, but I want my money to immediately earn passive income. If you have just started investing, putting all your money into a single stock is extremely risky and not the wisest use of your money, in my opinion
How do you buy Amazon stock without sinking your entire life savings into the market?
While you can buy fractional shares of individual companies on some online investing sites, mutual funds and ETFs also let you own a small piece of many companies with expensive individual stocks.
For example, if you want to invest in Facebook, Netflix, Google, Amazon, or Apple, some S&P 500 funds will let you invest as little as $100 per trade. Google or Amazon might each only be 1% of the total portfolio, but you can still capture any future gains from these companies.
Stop Wasting Time Picking Stocks
For full disclosure, I do own five individual stocks, but the overwhelming majority of my portfolio is composed of active and passive mutual funds and ETFs. I like the additional exposure to select dividend-paying blue chip companies that I believe make good long-term investments.
Before I bought these stocks, I spent several days researching to ensure they were a good buy. Although I’m in a financial position to buy more individual stocks, I don’t have the time to research potential buys and monitor the performance of more than a handful at one time.
I’m sure you don’t have time to watch every market move either. That’s why funds are so popular too. We trust the fund manager to make smart investing decisions because it’s their profession and they know more about the market than us casual investors. We can focus on saving for retirement, picking the kids up from school, and finishing the work project while the fund manager analyzes the P/E ratio, and K-10 reports.
You should still research the performance and fundamentals of a prospective mutual fund or ETF before you make a trade. Read the prospectus to familiarize yourself with the fund investment strategy, analyze the holdings, and compare similar funds’ expense ratios and holdings.
Even though the fund manager handles the day-to-day administrative duties like portfolio rebalancing, it’s still your responsibility to exercise due diligence. At the end of the day, it’s still your money, ask anyone who invested with Bernie Madoff.
There’s a Fund for Every Asset Class and Investment Strategy
While mutual fund and ETF investing are sometimes considered boring compared to the thrill of discovering the next Amazon, Google, or Microsoft, investing in funds can be exhilarating.
Your only investment option isn’t the passively managed index funds that only try to match the performance of a particular index like the S&P 500, Russell 2000, or the Dow. Numerous funds let you invest in specific sectors (technology, consumer staples); commodities (precious metals, alternative energy); and different asset classes (developing markets, domestic large-cap growth, small-cap value).
There are thousands of funds to choose from that can make investing fun and lucrative while maintaining a diversified portfolio. International funds can be a great way to invest in foreign markets that periodically outperform the U.S. market and for some additional portfolio diversification.
Automatic diversification at a low trading price might be the best reason to buy funds because anyone with the smallest income can invest and let every penny earn compound interest. Since funds make investing simple and affordable for even the most inexperienced of investors, mutual funds and ETFs can be the most valuable financial tool you can use to accomplish your money goals.