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Ramit Sethi recommends avoiding one of the most popular types of investments. Find out why and see where he says you should invest your money.
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People often associate investing with picking stocks. After all, a lot of investing advice focuses on which companies to buy and how to build a good portfolio. You might assume that buying and selling individual stocks is the way to go.
Not so fast. Ramit Sethi, host of How to Get Rich on Netflix, recently shared his opinion that “In general, individual investors should AVOID individual stocks.” On his pyramid of investing options, he ranked individual stocks at the very bottom, along with individual bonds and cash.
It may go against the typical vision of investing. But for many investors, Sethi’s advice makes sense and is worth following.
Why individual stocks aren’t the best option for the typical investor
There are two reasons why Sethi puts individual stocks at the bottom of his investing pyramid:
They’re very inconvenient to choose and maintain.They have extremely unpredictable returns that often fail to beat the market.
Inconvenience is one of the big drawbacks of investing in individual stocks. Putting together a quality portfolio is hard work, and it’s time-consuming. For a properly diversified portfolio, it’s recommended that investors own at least 25 stocks across a variety of different industries.
One popular piece of advice is to invest in what you know, and that works, to an extent. But let’s say most of your knowledge lies in tech companies. If you only invest in those companies, your portfolio will be far too heavily weighted toward a single industry.
You’ll most likely need to spend quite a bit of time and energy researching companies to build a portfolio of individual stocks. After that, you’ll also need to keep up with how those companies are doing and decide when to make changes. It’s not impossible, especially since quality stock brokers have plenty of research available for clients, but there are much easier options.
Where to invest your money instead
Sethi recommends that instead of picking individual stocks, investors put their money in index funds or target-date funds. These are funds that invest your money for you, which means there’s much less work and time required on your part. Both are great options, so here’s more on how each of them work.
Index funds
An index fund is an investment fund designed to track the performance of a market index. For example, an S&P 500 index fund will mimic the performance of the S&P 500, a stock market index made up of 500 of the largest publicly traded companies on U.S. exchanges.
Here are the main benefits of investing in index funds:
They have very low fees.They’re diversified since they contain a large number of stocks.Many of them have historically earned competitive returns. For example, the S&P 500 has an average return of about 10% per year.
Target-date funds
A target-date fund is like a retirement plan in a single investment fund. Each one has a specific retirement year, and the fund’s investing strategy is based on that year. For example, if you choose a 2055 target-date fund, its asset allocation will be optimized toward retiring in 2055. This makes them as convenient as it gets. However, you also have the least amount of control with this type of investment. That’s why some investors prefer other options, such as index funds.
Deciding how you want to invest
Sethi says that by sticking to investment funds, you can focus on how to grow the amount you invest, instead of which stocks to pick. That’s definitely a big advantage of index funds and target-date funds.
This doesn’t mean every investor should avoid picking stocks. Some people want to have full control over their portfolios. There are also those who enjoy learning about companies and choosing individual stocks themselves.
If that sounds like you, then you may want to split the difference. Put most of your money in index funds or a target-date fund, but also reserve anywhere from about 5% to 20% of your money for stock picking. This way, you get the excitement of picking stocks when you want it, but you still have most of your money in a more reliable and convenient option.
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The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.Lyle Daly has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Netflix and Target. The Motley Fool has a disclosure policy.
