Many people invest for their retirement in a 401(k), but those accounts are managed by employers, and the options offered within the plans are generally limited. But when you're ready to take the plunge and begin to invest outside of an employer-sponsored plan, your options are essentially limitless. With that much freedom, it can be hard to know where to start.
You hear all the famous quotes, cliches like “invest in what you know,” “never lose money,” or “the biggest risk is not knowing what you're doing.” But when you're just getting started, those don't really mean much.
So here's a pearl of wisdom for you that might: Learning to be a good investor takes time, so start slow and keep it simple. The first simple question to ask yourself is: Should I begin with individual stocks or exchange-traded funds (ETF)?
To illustrate, let's take a look at one of the most popular stocks and one of the most popular ETFs.
If you subscribe to the “invest in what you know” theory, then you know Apple (NASDAQ: AAPL), at least as a consumer. Millions of people use its products every day, and the odds are about even that you own one. You may already know that it is the world's largest public company, with a market cap of $2.8 trillion. But did you know its stock price has had an average annualized return of 23% over the last 10 years as of March 25, and since it went public in 1980, it's delivered annualized returns of 19.1%? Apple is currently trading in the neighborhood of $174 per share, down about 2% year to date.
It has averaged a 15% annual increase in earnings over the past 10 years on an annualized basis and a roughly 9% annual increase in revenue over that period through March 25. Those are both strong results.
From a business perspective, it's pretty clear that Apple is dominant in its primary niche — smartphones. Its market share is more than twice that of its closest competitor.
Next, consider debt, and more specifically, the debt-to-equity ratio, which shows how much a company relies on borrowing to finance its operations. While gauges of this metric vary by industry, generally speaking, anything under 2 is considered good. Apple's is 1.48.
Free cash flow is also an important metric to consider because it indicates how much cash the company generates after its operational expenses are subtracted. Apple's free cash flow is $101 billion now, and that metric has risen significantly over the past few years. Having strong free cash flow gives a business the ability to invest in new products and services, and to fund dividends.
Also look at operating margin, as it indicates how much profit a company generates on a dollar of sales after expenses are taken out. In Apple's case, it's about 31%, which is a good solid number. You also want to look for catalysts — new products, acquisitions, etc. — that could help the company sustain its advantages and gain market share.
Apple checks off all the boxes as a great company, which is why investors like Warren Buffett like it: It's now the largest holding in Berkshire Hathaway‘s stock portfolio.
SPDR S&P 500 ETF Trust
The SPDR S&P 500 ETF Trust (NYSEMKT: SPY) is the oldest ETF on the market, as it basically pioneered the exchange-traded fund concept back in 1993. It is also the largest ETF in terms of assets. The concept is pretty simple — it invests in all of the companies in the S&P 500 weighted by market cap. It's just like an index mutual fund, only it trades like an individual stock.
So, as Apple is the largest company in the S&P 500, it is the largest holding in the SPDR S&P 500 ETF Trust — accounting for about 7% of its value as of March 24. Microsoft is second at about 6%, followed by Amazon at 3.7%, Alphabet at 2.2%, and Tesla at 2.2%. The relative sizes of its holdings will shift over time depending on how the S&P 500's components rise and fall. Throughout the 1980s, the largest company was IBM. In the 1990s and into the 2000s, the top spot was held by General Electric and Microsoft at various times. In 2010, it was Exxon.
As of Feb. 28, this ETF had posted an annualized return of 10.2% since its inception in 1993. Over the last 10 years, it has returned 14.4% annually. Year to date, though, it's down about 5%, trading at about $550 per share.
Which is the better first investment?
While Apple is a fantastic company that has outperformed the S&P 500 over the years by pretty much every measure, the easy recommendation for me is the S&P 500. The SPDR S&P 500 ETF Trust is just one of several S&P 500-based ETFs, and all are pretty much the same — although some have lower expense ratios.
If you are a beginner, this is the perfect investment because you get access to a host of great companies, including Apple. While all of its holdings are large and mega caps, they are broadly diversified across an array of industries, so in a market environment where some sectors aren't performing well, you'll have holdings in others that thriving. For example, technology stocks are struggling now, but the energy and financial sectors are doing fairly well.
Also, the components of the S&P 500 will change over time. While not all of the 500 largest public U.S. companies are in the index, nearly all of them are, and as businesses grow (and shrink), some are added to it as others are removed.
A decade from now, Apple may still be the biggest company — or it may not. It's possible that some company that most of us haven't heard of yet will come along and replace it. With this ETF, you'll be invested in that company, too.
Start your portfolio with an S&P 500 ETF, and then as you go along and gain more knowledge about investing, you can build your portfolio around it.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool owns and recommends Amazon, Apple, Berkshire Hathaway (B shares), Microsoft, and Tesla. The Motley Fool recommends Alphabet (A shares) and Alphabet (C shares) and recommends the following options: long January 2023 $200 calls on Berkshire Hathaway (B shares), long March 2023 $120 calls on Apple, short January 2023 $200 puts on Berkshire Hathaway (B shares), short January 2023 $265 calls on Berkshire Hathaway (B shares), and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.