At 29, I Have $270K in Individual Stocks. Is It Time to Switch to Index Funds?

Dear Wealth Wise: I'm 29 and trying to build retirement wealth. I have most of my assets in my Roth IRA, 401(k), and HSA: over $270k in total, with about $220k in the Roth IRA. I mostly hold individual stocks, and I'm not sure whether it makes more sense to switch to index funds and accept market-adjacent returns or stay concentrated. I don't want to lose what I've built, but I don't want to give up valuable growth this early in my retirement savings. I am ready for a "set it and forget it" portfolio, but I also have experience researching stocks, so I'm wary of going all in on index funds. — Passive Curious

Dear Passive Curious: Before we dive into your question, we first want to note how far ahead of most young investors you are. If you left your total savings of $270,000 invested and didn't save another penny, you would have $2.05 million at age 60, assuming a conservative 7% return. So, well done!

While your youth gives you more runway to experiment than older investors might have, your question is spot-on for anyone weighing the upside of stock picking against the simplicity of index funds.

From just $107.88 $24.99 for Kiplinger Personal Finance

Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues

CLICK FOR FREE ISSUE

Sign up for Kiplinger’s Free Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

Many investors prefer index funds over taking their chances with a portfolio of individual stocks. The S&P 500 index has rewarded investors with an average annual return of about 10% (or about 7% after inflation) since its inception in 1957.

In fact, Warren Buffett, one of the most successful investors of our time, agrees that everyday investors are well served by loading up on index funds over the long term.

In his 2013 Berkshire Hathaway shareholder letter, Buffett said, "The goal of the non-professional should not be to pick winners — neither he nor his 'helpers' can do that — but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal."

At 29, you might easily have a 30-year window to build wealth. Will a shift to index funds mean selling your goals short? Here’s what the experts have to say.

It’s a matter of how much risk you want to take on

The good thing about being 29 is that you’re young enough to take on risk in your portfolio. But the question you want to ask, says Danielle Arlotta, CFP and founder at Sole Financial, is "Can you continue to pick stocks for the rest of your life?"

"I’m sure that you’ve heard most active managers underperform their benchmark," Arlotta says. "It’s good that you’ve done your research and know what you’re buying. It sounds like you have been able to outperform the market as well. But one bad pick and you can also suffer significant losses."

As Arlotta explains, indexing works because it gives you instant diversification, which helps reduce portfolio volatility. As you get older and your risk tolerance starts to wane, it's important to recognize that benefit.

Keep in mind that broad indices like the S&P 500 are market-cap weighted, meaning that just a few mega-cap tech giants (like the Magnificent 7) make up a big slice of the fund. If you want true broad-market diversification, consider pairing an S&P fund with an international index, for example.

Holding individual stocks isn’t gambling

You’ll often hear that index investing is safer than holding stock individually. Vincent Garaventa, CFP and vice president at Bauman Wealth Advisors, says that has some validity. But not every individual stock holding is speculative.

A well-researched, diversified portfolio may not be risky off the bat. The key, according to Garaventa, is to monitor your investments and rebalance as needed over time. You don’t want to remain too concentrated in a single company or market sector, so you’ll need to actively manage your portfolio.

"If done in the right amounts with the right portion of the portfolio," Garaventa explains, "there can be value for some diligent, disciplined investors in mixing in individual stocks or more targeted, themed investment funds."

Consider a hybrid approach: The core-satellite strategy

You may have the time and energy to follow individual stocks now, including the due diligence of reading 10-K reports and listening to earnings calls. But if you start a family or your work intensifies, index funds may look far more attractive. Arlotta says there’s nothing wrong with shifting to a "set it and forget it" strategy, but it doesn’t have to be all or nothing.

"Since you already have a majority of individual stocks, you can allocate all future contributions to index funds and rebalance when necessary," she says.

Arlotta's solution is easy to manage and avoids selling your stock positions. But there's another approach if you want to be more hands-on.

Garaventa suggests a core-satellite strategy, where the "core" of your portfolio consists of stable index funds and the "satellite" holdings can aim to beat the market.

"You siphon off a smaller portion of your portfolio and allocate it to your higher-risk investments, like individual security selection, and then run the core of your portfolio in a variety of index funds in a set it and forget it type of plan," he says. "This is a great way to balance the profit potential of individual stock selection with the high probability of index investing."

Advisers typically suggest that investors following the core-satellite strategy devote 80% or 90% to the core index fund portfolio and the remaining 20% or 10% to stocks. Many advisers recommend that no individual stock make up more than 5% of the portfolio.

Garaventa says it’s also important to consider the rate of return your plan needs to meet your goals.

"Sometimes that rate of return may be lower than one might anticipate, and investors may decide to use a higher-probability, index-only strategy where they’re not seeking significant outperformance beyond the benchmark because they’ve run the numbers and understand that their plan doesn’t require them to outperform the index," he says.

Of course, Garaventa acknowledges that most investors are wired to want higher returns, even if those returns aren’t needed to cover their future spending needs. It’s less about greed than ambition.

Plus, a 29-year-old investor doesn’t know what the future holds in terms of career growth, inflation, and AI-related disruption. Having more money than less only puts you in a stronger position to manage whatever the future holds.

At the same time, Garaventa says, "It’s important to consider the drawbacks and the higher risk. In my view, if you don’t want to leave individual stock selection behind, there’s value in doing both, as long as you do it in portions that are reasonable for your plan."

Keep in mind that there are tax ramifications for the location (or type of account) where you've stashed your funds. On the plus side, you can reallocate the $220,000 in your Roth IRA without a tax hit. That would not be the case if those funds were held in a taxable brokerage account. But if one of your stocks suffers a permanent loss in your Roth account, you can't harvest tax losses.

You’ve already won the hardest part of the early wealth-building game. Moving into index funds isn’t conceding defeat — it’s building in your lead so you can spend less time managing your money and more time living your life.

Read More

• Retirement Calculator: How Much Do You Need to Retire?
• Why Invest In Index Funds When Prediction Markets Pay Big?
• Invested in Index Funds? Here's What You Need to Know About Mega-Cap IPOs
• They Retired With $10 Million. Should They Still Invest Aggressively?