When it comes to building an investment portfolio, you have choices. You could load up on index funds, or you could buy individual stocks.
The benefits of choosing index funds is getting to own a whole bunch of different companies with a single investment. If you buy shares of an S&P 500 index fund, for example, you'll effectively own 500 different companies.
Index funds are great because they take a lot of guesswork out of investing, and they don't require the same intense research individual stocks do. But if there's one clear drawback to index funds, it's that they won't let you beat the broad market. That's because their goal is to match the market's performance, not exceed it.
If you have loftier goals, hand-picking stocks may be your best bet. But before you add your next stock to your portfolio, you should make a point to run through these key questions.
1. Do I see myself owning this company for 10 years or longer?
It can take a fair amount of time for a company's stock to gain significant value, or for a stock to recover from a bad earnings report or bout of unfavorable news. That's why, as a general rule, you should really only buy a given stock if you intend to hold onto it for many years. If you're not sure you want to commit to that time frame, then it may be that the stock in question isn't right for you.
2. Does this company have an edge over its competitors?
There are plenty of businesses that do a good job of generating revenue, maximizing cash flow, and limiting debt. But that alone doesn't necessarily make a given company a good buy.
Before adding a stock to your personal investment mix, consider whether the company at hand brings something to the table that its competition doesn't. It may be that the company has a savvy management team or an unmatched ability to innovate. Those are good reasons to choose one company over another.
3. Does this company lend to diversity in my portfolio?
Maintaining a solid level of diversity in your portfolio could help you grow a lot of wealth over time. It could also provide some degree of protection during periods of market turbulence.
Index funds do a great job of helping investors diversify. But if you're more focused on individual stocks, the next time you're tempted to buy one, figure out whether it will help you create or maintain a nice mix of assets. If you already own seven or eight healthcare stocks, for example, you may not want to buy another healthcare company if your plan is to limit your portfolio to 20 stocks in total.
Ask the right questions
Buying stocks isn't something you should do on a whim. Rather, you should put a lot of thought into the process. By running through these important questions, you may be less likely to regret your stock-buying decisions — and end up wealthier in the long run.
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