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Which One to Buy: Stocks or Index Funds?

There are a number of investment options available to you such as stocks, bonds, ETFs, and mutual funds that can be used in order to help you save and grow your wealth.

But it is important to keep in mind that not every investor has knowledge about the market and experiences that ultimately help them reach an investment decision. While some investors are attracted by stability and regular dividend-paying stocks, others look for small-caps that can give them a tremendous growth opportunity over the years.

Here we look at two such instruments for equity investors (stocks and index funds or ETFs) that can be leveraged to generate wealth over the long-term.

We know that stock investments are shares of a publicly-traded company that investors can buy and sell on a stock exchange. Similarly, index funds or exchange-traded funds track a basket of stocks such as the S&P 500 or the TSX Composite.

Benefits of investing in stocks

When you invest in shares of a company, you become a part-owner of the company. The profit or loss you earn on these investments depends on the performance of the company.

If a company performs really well over time, the profit the company makes is indirectly shared with you and similarly, if a company doesn’t perform well, your investments may lose significant value.

Investors use a number of strategies and incorporate a lot of research before they decide to invest in a company’s stock. This makes stock investments extremely flexible and personalized as investors get to decide where they want to invest based on their knowledge and instincts. In short, you get the personal freedom of choosing whichever stock you want.

Stock investments can give you unimaginable returns if you manage to find the right company at the right time. If you hold stocks long enough, it is very likely your investments grow at a staggering rate. They also give you diversification to a certain extent, if you include various companies across sectors and build a portfolio of quality small-cap, mid-cap, and large-cap companies.

For example, if you invested $1,000 each in shares of Apple, Amazon, and Netflix 10 years back you would have returned a cumulative $50,000 today. Similarly, a $1,000 investment in Shopify’s IPO would have ballooned to $60,000 today.

Further, stock investments allow you to outperform the market but it all depends on your ability to identify winning bets consistently.

Benefits of investing in index funds

Exchange-traded funds are similar to a basket of stocks that include companies tracking a certain market index. Investors own shares of many companies indirectly through index funds. There are different indexes that you can track using ETFs.  

According to TheMotleyFool, investing in index funds can decrease the time you spend on selecting and researching stocks for your portfolio. Index funds are also a great investment because of the range or diversification it provides. You can access to hundreds or even thousands of companies in a readymade portfolio and the risk involved in index funds is significantly lower as compared to stocks.

According to thebalance, index funds or ETFs are also cheaper as a fund’s composition rarely changes. Investors do have to pay a small fee known as the MER i.e. management expense ratio. This fee can vary on the kind of index fund you are looking at but generally, ETFs are very cost-effective.

Which is the right choice for you?

Both index funds and stocks provide more benefits than cons to investors. It simply depends on an investor’s goals, knowledge, and objectives for deciding whether one should choose the first or the other.

We can see that investing in individual stocks may give you the ability to generate market-thumping returns but they carry significant risks. Alternatively, ETFs will provide you with stable returns and diversify your risks.

If you do not have the time or knowledge to pick individual stocks you can invest in ETFs regularly to build long-term wealth. Even if you are knowledgeable about stocks, it is advisable to allocate a significant portion of your investments to ETFs such as the S&P 500. 

Investing in index funds is one of the easiest and effective ways for investors to build wealth. The best part is you don't have to become a stock market expert to do it.

A good investor knows that diversification is the best way to maximize returns and minimize risks.

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