How to Invest: Use Funds for Instant Diversification — But Don’t Pay an Arm and a Leg

There are so many different ways to invest.

Growth stocks, value stocks, big stocks, small stocks, stocks with high dividends, stocks with no dividends at all. It almost sounds like something out of Dr. Seuss.

And then there’s choosing the way to invest. In mutual funds or individual stocks? In traditional or exchange-traded funds? In passively managed index funds or actively managed ones?

If you love researching companies and reading annual reports, then individual stocks might be the way to go. Just don’t forget that a portfolio of one or two stocks isn’t really a portfolio. It’s a bet on one or two companies, and the fortunes of those companies, not the market, will determine your return.

Most of us don’t have the time or the confidence in our financial acumen to do that kind of work. That’s what funds offer. Instant diversification. They hold many stocks.

Passively managed funds–whether exchange traded or traditional mutual funds — take choice out of the equation. They simply hold a basket of stocks that track an index like the S&P 500 or the Nasdaq 100. Actively managed funds have portfolio managers working hard trying to beat the “market” or an industry benchmark.

Whichever you choose, it’s that instant diversification that makes a fund worth paying for. Which brings us to another key consideration: expenses.

Someone needs to get paid for the work of creating and running a fund. So in addition to selecting the right fund, you need to pay attention to the fees that funds charge. Those fees reduce your investment returns.

Bottom line: Pick the fund that matches your objective — but don’t pay too much.

We’ll dive into funds in this video. But first, a quiz:

How many stocks do textbooks say you need to hold to be “diversified?”

Watch this video for the answer and much more.