Should You Invest in Stocks or ETFs? 3 Questions to Ask Yourself
Investing in the stock market can be a fantastic way to meet your long-term financial goals, whether that's saving for retirement, building a college tuition fund for a child, or simply building your net worth.
However, where you choose to invest can make or break your finances. Investing in individual stocks may be the most obvious way to buy into the stock market, but it's not your only option. Exchange-traded funds (ETFs) can be a simpler, more straightforward approach, but they have their drawbacks as well.
Both can be smart options, but the one that's right for you will depend on your unique situation. Before you buy, ask yourself these three questions to determine which strategy can best set you up for success.
1. How much time can you put toward your portfolio?
Investing in individual stocks is often far more time- and research-intensive than buying ETFs. You'll need to research many different aspects of each company you're interested in buying, from the business's financials to its leadership team to how it fares against its competition.
A well-diversified portfolio should contain at least 25 to 30 stocks across a variety of industries, so building a strong roster of individual stocks is often a long process. With an ETF, each fund will often contain hundreds of stocks, either from a single sector or multiple industries. It's possible, then, to diversify your portfolio with just one investment.
There's no right or wrong approach here, but everyone will have different preferences when it comes to investing. If you have the time and interest to build a customized portfolio, investing in individual stocks can be a smart choice. Otherwise, an ETF may be a better option.
2. How much risk are you comfortable with?
Buying individual stocks can also sometimes carry more risk, because it's entirely on you to ensure your portfolio is solid. If you own 25 stocks and several of them end up being poor investments, you could potentially lose a lot of money.
ETFs can be risky, too, especially more niche ETFs that only contain stocks from one sector of the market. However, because they often include dozens or hundreds of stocks, that extra diversification can help limit some of that risk.
For the more risk-averse investors, you could also opt for broad-market funds like an S&P 500 ETF. This type of fund tracks the S&P 500 as a whole, containing all the stocks within the index. It's extremely likely that the S&P 500 will earn positive returns over decades, so the risk associated with this type of investment is far lower than what you'd generally see with individual stocks.
3. What types of returns are you looking for?
Perhaps the biggest advantage of buying individual stocks is that they can be much more lucrative than even the strongest ETFs. When you're filling your portfolio with stocks that you've hand-selected for their growth potential, you can ensure you're only investing in the best of the best.
With ETFs, you can't choose which individual stocks make it into the fund. Because each ETF contains so many stocks, there are bound to be some underperformers. That's not necessarily a bad thing, but it can limit your earning potential.
In general, safer investments tend to see lower returns overall. An S&P 500 ETF, for example, can only ever earn average returns because it's designed to follow the market. If your biggest priority is limiting risk, this type of investment can be a fantastic option. But if you're looking to beat the market, it's sometimes harder to do that with an ETF.
There's no single correct way to invest, and both individual stocks and ETFs can be smart ways to get involved in the stock market. By considering your goals, preferences, and risk tolerance, you can decide on the best approach for your situation.
Don’t miss this second chance at a potentially lucrative opportunity
Ever feel like you missed the boat in buying the most successful stocks? Then you’ll want to hear this.
On rare occasions, our expert team of analysts issues a “Double Down” stock recommendation for companies that they think are about to pop. If you’re worried you’ve already missed your chance to invest, now is the best time to buy before it’s too late. And the numbers speak for themselves:
Amazon: if you invested $1,000 when we doubled down in 2010, you’d have $21,022!*
Apple: if you invested $1,000 when we doubled down in 2008, you’d have $43,329!*
Netflix: if you invested $1,000 when we doubled down in 2004, you’d have $393,839!*
Right now, we’re issuing “Double Down” alerts for three incredible companies, and there may not be another chance like this anytime soon.
*Stock Advisor returns as of October 7, 2024
The Motley Fool has a disclosure policy.
Should You Invest in Stocks or ETFs? 3 Questions to Ask Yourself was originally published by The Motley Fool