investing

Why You Need to Invest in Funds Before Stocks

When you're just starting out with investing, you first need to build a diversified core before betting on individual stocks.

I’ve recommended many stocks. But I own just one: Amazon.com (AMZN). As an investment writer, I’ve learned that it’s hard to find an industry that the e-commerce giant isn’t disrupting these days. “Amazon’s world takeover continues,” I wrote shortly after the e-commerce giant bought Whole Foods. Some time later, I bought a couple of shares in my Roth IRA, and I plan to hold them forever. I felt secure in making a big bet on a single world-beating company because, despite what I said a few sentences ago about owning just one stock, I actually own thousands. When I began investing, I took the advice of Kiplinger’s, my dad and virtually every certified financial planner on the planet and spread my assets among several exchange-traded funds and low-cost mutual funds.

Most of the money I’m able to set aside for investing goes to feed the funds in my retirement accounts. But over the years, I hope to funnel money into more individual stocks. Although diversifying is a sensible way to build an investing foundation, buying individual stocks is a challenging, gratifying and fun way to keep up with your investments. Let’s face it: You don’t get quite the same thrill when the broad stock market gradually boosts the value of your ETF as you do from being right about a great company and then reaping the benefits.

But for millennials, assembling a portfolio of individual stocks can be a challenge. An investor could theoretically build a diversified portfolio with about 30 individual stocks, says Ashley Foster, a CFP in Houston. That’s enough to spread money among companies of various sizes in an array of industries, representing both growth-oriented and bargain-focused investment styles.

A Couple of High Bars

But that strategy presents two hurdles for young investors. One is price. You could recently buy a single share of Apple for $191. Amazon? It trades for $1,813 a share. A well-rounded portfolio of individual stocks could easily cost tens of thousands of dollars. The other hurdle is that investing in stocks requires extensive research and diligence. If you don’t have the time to properly bone up on—and keep track of—individual stocks, it’s wise to “protect against ignorance,” as investing icon Warren Buffett says, and diversify your holdings.

Buffett has said that diversification is for “know-nothing” investors. Who might that be? Well, me. And my dad. And you, probably—anyone who isn’t going to spend a career trying to outperform the stock market. A diversified investor likely won’t suffer a huge loss when one stock or one part of the market goes downhill, because chances are that there will be offsetting gains in another corner of the market (there’s always a bull market somewhere).

But once you’ve laid that well-diversified foundation, you might want to layer on individual stocks. I’ve opted for and would recommend a hybrid strategy—what David Mullins, a CFP in Richlands, Va., calls “core, then explore.” My diversified retirement funds are the core. As I earn more money and learn more about the market over the years, I suspect that I’ll add more stocks to the explore portion of my portfolio.

If you’re opening a new account to trade stocks, opt for a brokerage with low fees and robust investment research tools. (Watch for our rankings of the best online brokers in the October issue.) Consider a tax-advantaged account, such as a Roth IRA. And if you need a few good stock ideas, see 6 Stocks to Buy and Hold Forever. Not all of your stock picks will work out. But some are bound to pay off. And when that happens, even us know-nothings feel as if we know a thing or two.

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