4 Reasons Why You Should Use Index Funds (by a stock picker)

I’m a stock picker.

That is, for the majority of my stock portfolio, I pick individual stocks. It’s not a decision I take lightly, since the data is against me. My alternative strategy would be to simply invest in index funds (which I do use for a portion of my portfolio via my retirement accounts).

For this post, I’ll evaluate that alternative strategy to understand what I’m up against.

So, here are 4 reasons why you should just use an index fund:

1. Performance

Over the long run, index funds have outperformed actively managed funds. In fact, according to a study by S&P Dow Jones Indices, over 80% of actively managed large-cap mutual funds underperformed the S&P 500 index over the 10-year period ending December 31, 2021.

Further, the average retail stock picker significantly underperforms the market.

By stock picking, you assume that you are above average. Because of this, it’s an inherently arrogant decision to pick individual stocks. You’re unlikely to do better than an index fund over the long run.

But maybe you are above average. Too bad we won’t really know for many years when we can look back at your long-term performance.

2. Diversification

Index funds offer investors the opportunity to purchase a large number of stocks in a single fund. They provide instant diversification.

At some level, diversification helps to mitigate the risk associated with investing in any particular company, which could go bankrupt or otherwise fall a lot in value.

3. Low Cost

Index funds tend to have far lower expense ratios than their actively-managed counterparts. So there isn’t a fee barrier that will dramatically hamper your performance when you use index funds.

4. Simplicity

Index funds are a simple way to invest in the market. You don’t have to worry about researching individual stocks, and you can get started immediately. Limiting your stress will help with that crucial “return on invested brain damage” metric.

So pick away! Just understand what you’re potentially missing out on with investing in index funds before you do.

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I am not a licensed investment advisor. As always, speak with a licensed professional if you need financial advice for your specific situation.