Index fund investing has exploded in recent years as folks flock toward low-cost investment vehicles. But it’s not just the low costs that have piqued investor interest. Index funds consistently beat the average mutual fund performance and hedge fund performance thanks to their simple structure, low fees, and automated process that strips out emotion.
The SPDR S&P 500 ETF Trust (NYSEMKT: SPY) is one of the best-known index funds. It has a staggering $ 408.1 billion in assets under management (AUM) and a gross expense ratio of just 0.094%. Yet the pool of total index fund AUM is well in the trillions.
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Despite their low costs, there are many reasons why buying an index fund may not be the best choice for you.
1. Free trades and fractional shares
One of the biggest barriers to entry for individual investors used to be high trading fees. It was not long ago that a single trade could cost $ 10, which made it very hard for a new investor to beat the market once fees were factored in.
Worst of all, high fees incentivized making big buy and sell orders all at once and made dollar-cost averaging every two-week paycheck basically impossible for the average retail investor. Therefore, mutual funds were seen as a lower-cost alternative.
Today, however, all the major brokerages offer $ 0 trading fees, which gives a retail investor more optionality. It also makes it easier to open a starting position in a stock you may be interested in, but do not want a large stake in right away. In today’s era of free investing, the low cost of an index fund isn’t as big a benefit as some make it out to be.
In addition to free trades, most brokerages allow investors to buy fractional shares of a company. Amazon (NASDAQ: AMZN) plans to issue a 20-for-1 stock split in early June. But for now, an investor has to fork over about $ 3,300 for just one Amazon share. That’s a large chunk of change just to open a starter position. However, buying fractional shares allows an investor to buy just $ 10 or even $ 5 of a stock, with a $ 0 trading fee to boot.
2. Limited growth opportunities
Another reason why many investors choose to invest in individual stocks instead of index funds is that they want exposure to specific companies at specific price points. The long-term return of the S&P 500 is an impressive 8% or so per year. But it’s no secret that many individual stocks have offered nothing short of life-changing wealth.
Today’s top companies used to be small businesses. And finding those businesses early can offer some explosive gains.
3. Specific goals and interests
Stock picking isn’t just about tapping into more growth potential. Rather, it’s also about investing in a way that suits your style. For many investors, owning 500 stocks is too much diversification. By operating a balanced portfolio, investors can be more deliberate in their investing strategy and concentrate on their best ideas.
For some investors, this may involve a certain sector, like technology or industrial stocks. Other investors may prefer sticking with dividend stocks, value stocks, or growth stocks.
Finally, many investors may want to get creative and structure a portfolio that is best suited for their particular needs. A younger investor with a longer time horizon may be more open to taking risks, while an older investor could be more interested in capital preservation and income.
Where to go from here
In today’s age of low fees, there’s no reason why you must take an all-or-nothing approach to investing. Rather, many investors could probably benefit from including an index fund in their portfolio as well as several individual stocks. It all depends on your interests and financial goals. But as long as you’re investing in quality companies, your strategy should have a good chance of paying off over time.
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