Index Funds vs. Individual Stock Investing

Martin writes in:

I’m glad to see you’re writing reviews of books like Payback Time instead of just blindly preaching about index funds. You’ll never make real money with them.

I’m including Martin’s note because he’s actually right: you’ll never be able to beat the market with an index fund.

But that’s not the point of an index fund.

Investment strategies like the one described in Payback Time or Real Money or any other book that describes an investment strategy that focuses on individual stocks have one thing in common. They all require a lot of homework.

Cramer, for example, in his excellent book Real Money (which is far, far superior to his television show) recommends holding at least ten different individual stocks at the absolute minimum to spread out risk – and basically suggests people should hold twenty or more. However, he suggests spending at least one hour per week per stock you own for homework, plus additional time to study stocks not yet in your portfolio. With a twenty stock portfolio, you’re easily approaching thirty hours per week every single week just to study your portfolio.

Some people who are passionate about investing may actually enjoy spending 1,560 hours a year studying their stock picks. Those people, however, are in the minority.

I’m not going to argue that there isn’t some financial gain for that time invested. I absolutely believe that individuals (who are investing relatively small amounts) absolutely can beat the market to a certain degree with significant homework.

The question is whether or not that time is really worth it.

For a person who is passionate about investing, those thousands of hours are enjoyable fun for their spare time. Studying stocks is their hobby – and it’s potentially a lucrative way to mill away the hours instead of consuming other forms of entertainment.

If you haven’t got that passion, though, all of those hours spent doing an appropriate amount of homework are going to seem an awful lot like work on top of the normal workload a person has. It essentially turns your free time into more work time just to squeeze a few more percentage points out of your investment dollars – and that’s if you can execute a good strategy well.

Alternately, people in that position can toss their investment money into index funds, sit back, and simply match the market. You’ll never beat the market, and you’ll likely never beat a focused person who does adequate research into stock picking.

But you also won’t be spending big chunks of your week doing something you don’t really enjoy just to earn a little bit more than you’re already earning.

To me, the answer comes down to this. If you have the passion, make individual stock investing your hobby. Study it. Invest using your research. You’ll be spending your time doing something you enjoy and probably earning some extra cash from it.

If you don’t have that passion, though, stick with index funds. They’ll earn well for you by simply matching the market and let you spend your spare time on something else that you value more.

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Trent Hamm

Founder & Columnist

Trent Hamm founded The Simple Dollar in 2006 and still writes a daily column on personal finance. He’s the author of three books published by Simon & Schuster and Financial Times Press, has contributed to Business Insider, US News & World Report, Yahoo Finance, and Lifehacker, and his financial advice has been featured in The New York Times, TIME, Forbes, The Guardian, and elsewhere.