Ohen it comes to building an investment portfolio, the choice is yours. You can load index funds or buy individual stocks.
The benefits of choosing index funds are owning a whole bunch of different companies with one investment. If you buy shares of a S&P500 index fund, for example, you will effectively own 500 different companies.
Index funds are great because they take a lot of the guesswork out of investing and don’t require the same intense research as individual stocks. But if there’s one obvious downside to index funds, it’s that they won’t let you beat the broader market. This is because their goal is to meet market performance, not exceed it.
If you have higher goals, manual stock picking may be your best bet. But before you add your next stock to your portfolio, you need to make sure you go through these key questions.
1. Do I see myself owning this business for 10 years or more?
It can take a long time for a company’s stock to gain in value or for a stock to recover from a bad earnings report or unfavorable news. That’s why, as a general rule, you really should only buy a particular stock if you intend to hold it for many years. If you’re not sure you want to commit to that time frame, the stock in question may not be right for you.
2. Does this company have an advantage over its competitors?
There are many companies that are successful in generating revenue, maximizing cash flow and limiting debt. But that alone doesn’t necessarily make a given company a good buy.
Before adding a stock to your personal investment mix, ask yourself if the company in question brings something to the table that its competitors don’t. The company may have a savvy management team or an unparalleled ability to innovate. These are good reasons to choose one company over another.
3. Does this company promote diversity in my portfolio?
Maintaining a solid level of diversity in your portfolio could help you accumulate a lot of wealth over time. It could also provide some degree of protection during periods of market turbulence.
Index funds do a great job of helping investors diversify. But if you’re focusing more on individual stocks, the next time you’re tempted to buy one, consider whether it will help you create or maintain a good mix of assets. If you already own seven or eight healthcare stocks, for example, you might not want to buy another healthcare company if your plan is to limit your portfolio to 20 stocks in total.
Ask the right questions
Buying stocks is not something you should do on a whim. On the contrary, you should put a lot of thought into the process. By going through these important questions, you are less likely to regret your stock buying decisions and become richer in the long run.
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