Most New Investors Don’t Have the Knowledge to Pick Individual Stocks

Index funds are better for most new investors than choosing individual stocks, bonds, REITs, or other securities because many new investors aren’t capable of studying the financial statements of the companies that issue these investments. Getty Images

If you are an ordinary investor, the odds are that low-cost index funds might be a better choice than picking individual investments. This is especially true if you can’t read a balance sheet. income statement. or cash flow statement.

1. You Can Save Money By Investing in Low Cost Index Funds

When you invest in low-cost index funds, the management fee, or expense ratio. can be as low as 0.10% of assets per year compared to 1% or 2% for other types of mutual funds. In practical terms, that means for every $100,000 you had in a Roth IRA or 401(k). you’d indirectly pay $100 in fees to the money management company compared to paying $2,000 with a more expensive actively managed fund. That is an extra $1,900 per year in your pocket. Over long periods of time, that is hundreds of thousands, or even millions, of dollars in additional wealth.

2. Low Cost Index Funds Provide Widespread Diversification at a Fraction of the Cost

If you wanted to replicate the S&P 500 by buying shares of each of the 500 stocks directly, you’d need to spend thousands of dollars in commissions and invest millions of dollars. With a low-cost index fund, you can often invest for as little as $500 through a retirement account or $3,000 through a regular brokerage account .

3. Low Cost Index Funds Exist for Multiple Asset Classes, Investing Strategies, Market Capitalization, and More

Low-cost index funds have become so popular that there are now mutual funds that cover nearly any investing mandate or asset allocation you could have. Want to only invest in small cap value stocks? Consumer staples? Energy stocks? International pharmaceuticals? There is an index that tracks it that would allow you to invest in a basket of the stocks for very little expense.

4. Low Cost Index Funds Can Be As Simple or Advanced As You Desire

There are index funds that are completely inappropriate for new investors, such as those that hold assets in foreign currencies. For all intents and purposes, an index fund is no more safe or unsafe than the underlying investments that it holds. If you put 100% of your net worth in an index fund specializing in junk bonds, you aren’t diversified, you just own a lot of different securities within the junk bond asset class. An index fund is just a type of mutual fund, not a specific type of investment.

5. Passive Investing in Low Cost Index Funds Means No Thinking About Individual Investments