Investment in index funds has skyrocketed in recent years as people flock to low-cost investment vehicles. But it’s not just the low costs that have piqued the interest of investors. index funds consistently above average mutual fund performance and hedge fund performance thanks to its simple structure, low fees, and automated process that takes the emotion out.
the Trust SPDR S&P 500 ETF (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%. However, the total fund of AUM index funds is well into the trillions.
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Despite its low costs, there are many reasons why buying an index fund may not be the best option for you.
1. Free trades and fractional shares
One of the biggest barriers to entry for individual investors used to be high trading fees. Not too long ago, a single trade could cost $10, making it very difficult for a new investor to beat the market once fees were factored in.
Worst of all, the high fees incentivized placing large buy and sell orders at once and made averaging the dollar cost of each two-week paycheck basically impossible for the average retail investor. Therefore, mutual funds were seen as a lower cost alternative.
However, today, all major brokerages offer $0 trading fees, giving the retail investor more options. It also makes it easier to open an early position in a stock that you might be interested in, but don’t want a big share of right away. In today’s era of free investing, the low cost of an index fund is not as great 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 shell out about $3,300 for a single Amazon share. That’s a lot of change just to open up a starting position. However, buying fractional shares allows an investor to purchase just $10 or even $5 of a share, with a $0 trading fee to start with.
2. Limited growth opportunities
Another reason many investors choose to invest in individual stocks rather than index funds is that they want exposure to specific companies at specific prices. The long-term return of the S&P 500 is an impressive 8% per year. But it’s no secret that many individual stocks have offered nothing less than life-changing wealth.
Today’s major businesses used to be small businesses. And finding those deals early can offer some explosive profits.
3. Specific goals and interests
Stock selection is not just about tapping into higher growth potential. Rather, it’s also about investing in a way that suits your style. For many investors, owning 500 shares is too much diversification. By operating a balanced portfolio, investors can be more deliberate in their investment strategy and focus on your best ideas.
Finally, many investors may want to get creative and structure a portfolio that best suits their particular needs. A younger investor with a longer time horizon may be more open to taking risks, while an older investor may be more interested in preserving capital and income.
where to go from here
In today’s era of low fees, there’s no reason you should take an all-or-nothing investment approach. 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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