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For anyone looking to start investing in the stock market, you’ll be faced with the pros and cons of individual stocks versus index funds. Stocks are shares of a company, whereas index funds are a portfolio of stocks and bonds that tracks the stock market.
Plenty of people avoid the stock market out of fear, but learning how it works can help you make the right choices to mitigate your personal risk. Here are the basics of how index funds differ from individual stocks, and how you can choose the right investment vehicle for your money.
The difference between stocks and index funds
The biggest difference between investing in index funds and investing in stocks is risk. With stocks, you own one share of ownership in a single company. With an index fund, you indirectly own stock in a number of different companies that make up the particular index, such as the S&P 500 or the Nasdaq 100. This gives you a more diverse portfolio—one that rises and falls with entire sections of the market.
Compare that to individual stocks, which tend to be more volatile with the potential for sharp peaks and valleys. The diversified nature of an index fund generally means less extremes. That means lower reward, sure, but also lower risk.
Choosing to invest in stocks versus index funds
For some, the drawback of index funds is a lack of control over your specific holdings. When you put your money into S&P 500 index funds, you can’t customize the individual stocks, and you can only earn average returns. Many individual investors are seeking the personal satisfaction that comes with playing the stock market game: Index funds aren’t the thrilling way someone might “beat the market” (an endeavor that we do not endorse).
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Of course, anyone buying stock knows it’s wise to build a well-rounded portfolio, as opposed to putting all your eggs in one basket. That’s why for most people—especially anyone who is getting into investing for the first time—index funds are a good place to start. Index funds can take away the stress of choosing specific stocks, and they usually cost much less than other investment vehicles. From there, you can start learning how to pick individual stocks—perhaps with the help of a financial advisor.
