If you are torn between investing in an index fund or directly in stocks, then you will find this index fund vs stocks comparison useful.
There’s so much confusion around this topic to the point that in many people’s minds index funds and stocks are like night and day.
With an index fund, you can also invest in stocks. And stocks are what most people want to invest in when buying an index fund. It’s just that when you invest in stocks through an index fund, someone else manages your money.
But, indeed, that may be the only major similarity. You have every right to wonder where they differ before you decide to go with either.
So, let’s answer exactly that, shall we?
Level of Engagement
The first difference is the level of engagement.
What I mean by that is the work investing your money will require on your part.
Investing in an index fund is a set-it-and-forget-it kind of deal. The only action on your part will be to just keep putting money into it over time (and that’s not necessary when you have a large sum from the start, a.k.a lump sum).
That’s basically all there is to it. Besides that, you don’t even need to check whether the index is up or down. After all, if you invest for the long-term, temporary changes don’t need to concern you.
Don’t forget that you pay annual fees to the fund manager for doing the work for you. You can let them worry about the management of the fund.
If you invest directly in stocks, it means that you will need to manage your money by yourself.
In order to understand whether that’s something that would interest you or not, you should take one very important thing into account…
Managing your own fund comes with the risk of losing money permanently.
With index funds that follow the broad market, you don’t have to worry too much about bumps in the road. The stock market generally goes up over time.
But with directly investing in stocks, that particular risk is driven to a large extent by your level of experience in investing. The less you know, the more probable losing money is.
If you have time to devote, then you should spend at least a year educating yourself on investing and managing a portfolio before you go down that route.
If you can’t do that, then without question, pick an index fund and call it a day.
Level of Control
The second difference is the level of control you can have over how you invest your money.
When it comes to the index fund vs stocks debate, this is a very important difference that scores a major point for individual stocks’ advocates.
Take portfolio weight for example. This is basically how much a specific company represents an index.
Since the index fund’s job is to mirror the performance of the index, it makes sense that as some companies grow over time, you could have more money in them than how much you would perhaps like to in the future.
In other words, the portfolio weights of certain holdings may grow larger over time and you can have no control over this. In contrast, stock pickers can control how much of their money is allocated to each company they invest in.
Besides that, you may have some ethical objections to some companies that your money is invested in when you invest it through an index fund.
For example, if you want to invest in the broad market, that could mean investing in companies where you don’t agree with their line of business.
In such a scenario, you just can’t have your cake and eat it too. You will have to choose between the two; the index fund that offers broad diversification or the individual stocks route that can better align with your ideologies.
And speaking of diversification, with individual stocks, you can better choose how diversified you are. But you can look at the matter like this too: index funds offer a diversification level that you may not be able to accomplish by yourself with a small sum of money.
Level of Risk / Potential Reward
Last but not least, another index fund vs stocks difference is the level of risk and potential reward.
When it comes to index funds, the risk is generally low; especially if you go with a broad-market index. But since these kinds of funds are not about beating the market but following it, you will never do better than the average Joe.
With stock picking, however, you have a chance at beating the market. I don’t want to make it sound easy though. Most of the time, this may seem like a fool’s game since a very tiny percentage of investors succeed at it.
But with a genuine interest, patience, and plenty of reading/practicing, it can be a goal within reach.
At the same time, risk (as we already mentioned) is generally higher when you pick stocks by yourself. So, you will need to make sure that you understand that before you proceed.
And remember that more risk doesn’t always equal higher rewards. After all, look at how most of the broad-market index fund investors do better on average over long periods of time than stock pickers.
Index Fund vs Stocks: Conclusion
In conclusion, an index fund and individual stocks differ in:
- The work you will be required to put into investing your money
- How much control you have over the weight distribution and holdings selection
- How much risk you take and what kind of performance you witness over time
So, before you invest in either, take into consideration those differences…
If you decide to go with an index fund, take a look at this guide to select the ideal fund for you.
But if you decide to go with stock picking, then we recommend you read these investment books first!
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Disclaimer: This information should not be viewed as financial advice. You should consult a financial advisor or do your own due diligence before you invest. The owner of this website and author of this article are not to be held liable for any undesired result by anyone who uses this information that is provided here in any way.
