Is a total market index fund a better choice than a broad portfolio of stocks?
A total market index fund is generally considered a better choice for most investors compared to attempting to assemble a broad portfolio of individual stocks, primarily due to superior diversification, lower costs, and simplicity. Total market index funds provide exposure to essentially all publicly traded stocks in a market (such as the entire U.S. stock market), including large-cap, mid-cap, and small-cap companies, thus reducing company-specific risk and the need for individual stock-picking skills.
Key
benefits of total market index funds:
- Diversification: One
fund can offer broad market exposure across thousands of companies and all
major economic sectors, lowering the impact of poor performance from any
single stock or sector.
- Low Cost: These
funds typically have very low management fees (expense ratios), which
helps investors keep more of their returns over the long term.
- Simplicity: Investing
in a total market index fund eliminates the need for constant research,
stock selection, and portfolio rebalancing. The fund automatically
maintains market-cap weighting and composition.
- Consistent Market Returns: Total market index funds are designed to capture
the long-term returns of the entire market, which historically have been
robust for patient investors.
- Reduced Risk of Major Underperformance: By avoiding concentrated bets on individual stocks or sectors, you reduce the risk of significant losses that can occur with less diversified portfolios.
Considerations:
- Limited Outperformance: Total market funds will not outperform the
overall market and may underperform if compared to a narrowly focused
portfolio in short periods of time. Still, consistently picking these
winners in advance is extremely difficult even for professionals. If
odds could be given, it’s likely that a total market index fund will be
among the best performers over extended periods. Indeed, few
professionals will come even close, and at noticeably higher cost.
- Exposure Still Favors Large Caps: Even total market funds are weighted by market capitalization, so large-cap stocks (often 70-80% of the U.S. market) dominate fund performance. In addition, you gain exposure to mid- and small-cap firms, offering additional growth potential and diversification.
When
might building a broad individual portfolio be preferable?
- If you have exceptional stock-picking skills, significant resources, and the time to manage and monitor a large portfolio, you could potentially outperform the market. That said, research indicates almost all individual and professional investors underperform low-cost index funds over time.
In
summary, for the vast majority of investors—including those seeking long-term
growth, low maintenance, and broad diversification—a total market index fund is
a highly effective and efficient investment vehicle.
N. Russell Wayne
Weston, CT 06883
203-895-8877
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