3 reasons to hand-pick stocks instead of buying index funds

Though index funds work well for the average investor, here’s why individual stocks may be a better bet for you.

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This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Investing in the stock market is a proven way to grow wealth over time, and the sooner you get started, the better. But deciding how to invest can be challenging. If you opt for a collection of individual stocks, you'll need to spend time researching each company and making sure it's the right fit for your portfolio. If you go with index funds, you won't have to put in the same amount of legwork, but you may lose out on certain benefits that individual stocks have to offer.

For many investors, index funds are actually a good way to go. But here's why you may want to hand-pick your stocks instead.

1. You can assemble a portfolio that best aligns with your strategy

Hand-picking your stocks allows you to choose companies that fit in with your personal investing strategy and appetite for risk. Say you're really not keen on putting airline stocks in your portfolio because you think that's a risky prospect given the hit the industry has taken during the coronavirus pandemic. If you buy S&P 500 Index (INDEXSP: .INX) funds, you'll be stuck with airline stocks in your portfolio, whether you like it or not. By choosing your own stocks, you avoid companies or industries you'd rather steer clear of.

2. You can avoid stocks that don't align with your ethics

Some people buy stocks because they believe in a company's growth potential. Other people buy stocks because they believe in the products or services being offered by a particular company, or because they believe in its mission. As just mentioned, when you buy index funds, you don't get to dictate which stocks land in your portfolio and which don't. This means that if you have a problem with a specific company from an ethical standpoint, you could end up having to invest in it anyway.

Imagine you're not a fan of tobacco companies. Since Philip Morris International Inc (NYSE:PM) is part of the S&P 500, if you buy funds based on that index, you'll end up owning its shares, which could pose a moral dilemma for you.

3. You'll have the potential to beat the market

Index funds aim to match the performance of the indexes they're tied to – not beat it. If you want your portfolio to deliver returns that exceed those of the broader market, then you'll need to assemble your own mix of stocks – ones with supreme growth potential and a clear edge over the competition. Beating the market isn't easy, but with the right approach, it can be done – but not with index funds.

What's the right move for you?

Ultimately, the decision to buy individual stocks versus index funds should boil down to how confident you are in your ability to choose the right companies, and how much time you're willing to spend in the process. If you're up for the challenge, then hand-picking stocks could be a great strategy that rewards you over time. But if you'd rather keep things simple on the investing front, then there's nothing wrong with reverting to index funds and enjoying the automatic diversity they allow for.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

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