Index funds have been a popular investment choice of late. This is perhaps more so ever since Warren Buffett said years ago that index funds are the best investment option for most average investors.
However, I would like to take a different angle and suggest two reasons why capable investors should try to actively manage their own portfolio instead of relying on an index fund.
Perhaps one of the biggest drawbacks of investing in index funds is that investors have little say over where their money is allocated. For instance, if you are invested in an index fund that is tracking the Straits Times Index (SGX: ^STI), your money will be automatically allocated to the 30 blue chip stocks that make up the index. You have no say as to the weighting of each stock, or if you wish to exclude any of the 30 companies.
On the other hand, if you manage your own portfolio, you have the freedom to pick and choose the stocks that you believe will outperform, while leaving out others you think have limited potential.
Furthermore, some investors who have personal preferences may want to avoid investing in certain areas such as the oil and gas sector, pharmaceuticals, the “sin” sectors, or others. If you invest in an index fund that consists of any of such stocks, your say in whether to own such stocks is zero, and you will have to invest in all the stocks that make up the index.
Investors who invest in individual stocks over index funds have the potential to reap better returns than the index. Owning an index fund, on the other hand, guarantees that you track the overall market’s return and have no chance of outperforming the market as a whole.
Make no mistake, I am not saying outperforming the index is easy to achieve. Most retail investors (and many professionals as well!) who invest in individual stocks end up with poor returns. This is because they employ poor stock picking strategies, or allow emotions to enter their decision making process. Choosing stocks that can outperform the market requires diligent research, knowledge, and emotional control.
Therefore, if and only if you believe you have the requisite traits, then building your own portfolio will be the better option.
The Foolish bottom line
There are many factors to consider before deciding whether to actively or passively invest your hard-earned money. If you have little time on your hands, or are not interested in researching stocks, then passive investing via index funds may be the right option. However, if you have the know-how and an interest in business and stocks, then managing your own portfolio will be more rewarding.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.