2 Risks of investing only in index funds | Smart Change: Personal Finance
(Morri Bachmann)
Some people consider themselves practical investors. They like to spend time researching stocks, comparing companies in the same industry, and reviewing financial statements to determine which companies should have a place in their portfolios.
Then there are those investors who prefer to take the easy way out by putting their money into index funds. These investors don’t have to do much legal work at all.
To be clear, there is absolutely nothing wrong with being one of those investors if this is an approach that works best for you. In fact, investment giant and billionaire Warren Buffett has long said that index funds are a great choice for the everyday investor.
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But while there is nothing wrong with loading up on index funds and holding them for the long-term, there are some pitfalls you may encounter if you go this route. It is important that you realize what they are.
1. You won’t be able to beat the market
When we talk about beating the market, we are referring to compiling an investment mix that provides higher returns over time than broad market indices such as Standard & Poor’s 500. Since index funds are simply set up to match the performance of different indices, they are not a good tool to beat the market. So, if that’s your goal, you’ll only really reach it by spending the time making up a bunch of individual stocks.
But perhaps beating the market is not your goal. And if you’re OK with matching the broad market’s performance, index funds are more than a suitable investment. Before you fall back on it, think about what your financial goals might look like.
2. You will have no say in the companies you own
Some people are passionate about certain issues and want an investment portfolio that matches that. One of the downsides to loading your portfolio with index money is that you won’t have a say in the different companies you buy.
So, let’s say you’re an environmental expert who is against some of the practices that some energy companies maintain. Well, if you buy index funds, those same companies may land in your portfolio. This is something you have to come to terms with, or take a different route.
Should you rely on index funds alone?
If you’re saving for a long-term accomplishment like retirement, index funds can be a smart bet—especially if you’re not a very experienced investor and don’t really want to become one. At the same time, there are certain drawbacks associated with index funds, so you may want to consider a strategy that focuses not only on these funds, but also on a few carefully selected individual stocks.
However, if you’re honest with yourself about the fact that you’re not really going to start looking for stocks, you’d be better off sticking to just index funds than buying stocks of individual companies at random. So think about the amount of time and effort you are willing and able to put in before making that call.
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