Is Investing in Index Funds Really the Way to Go?

Jeremy Biberdorf  |

Written by Jeremy Biberdorf

There has been much talk recently about the trend towards choosing index funds as opposed to investing in individual stocks. No doubt some of this preference is due to the current volatility of the stock market. It's certainly true that there has been a marked increased in this investment behavior.

However, this trend has not just been restricted to recent months. It's been happening since the global financial crisis took it's toll. In 2017, 35% of total fund assets in the US were index funds. This is 20% higher than was the case 10 years earlier. Given the way the stock markets were affected back in 2008, it's perhaps understandable that when investors are considering the stock market pros and cons they are attracted to the less risky option of index funds.

Why are index funds so appealing?

When the global financial crisis hit, in 2008, many investors suffered heavy losses. As the world of finance started to recover, it seemed logical to many to spread the risk over several different stocks, rather than place everything into one. The same logic applies in today's volatile markets.

Another benefit of index funds, in the choice between individual stocks or index funds, is that in-depth research and due diligence are not required. Investors place their cash into a range of stocks that is created to mimic the markets, so checking the reliability, and predicting the performance, of an individual company is not necessary.

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Is this really the best option?

The age old question of stocks vs index funds will continue to be asked. The answer to which is best depends on the individual investor and their requirements. While it's true that many people seem to be choosing index funds as the best option, this may not be the case for everyone.

Investors who are seeking a regular dividend may not be best served by an index fund. Many stocks do not provide a dividend option, so it follows that in the selection of stocks provided by an index fund, dividends would not be optimised. A better choice may be to select specific stocks that provide a decent dividend.

Individual stocks can also produce better returns as they are not hampered by falls in other stocks in the way that high performing stocks in an index fund are. In other words, if a stock in an index fund preforms well, overall profits are reduced if other stocks in the fund fall. By investing in a single stock potential profits are optimised, but risks are also increased.

There is no one size fits all best option when it comes to investing. Index funds help investors manage risk but higher potential profits, and dividends, come from investing in single stocks. It could be that the best option is to invest in an index fund and choose a separate stock to invest in as well. Of couse, this is only a good idea for an investor who is willing to do the research and due dilligence required for single stock investing. Otherwise, an index fund may be the best way to go.

Stock price data is provided by IEX Cloud on a 15-minute delayed basis. Chart price data is provided by TradingView on a 15-minute delayed basis.

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The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer.

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