Investing in Total Market Funds vs. Individual Stocks
Picking stocks has higher potential returns, but it’s very difficult to choose the right companies. Investing in a total market index fund is more reliable.
April 22, 2022
This article is provided for informational purposes only and should not be construed as legal or investment advice. Always consult with a professional financial or investment advisor before making investment decisions.
There are many things to invest in but stocks typically offer the best long-term returns.
But what stocks should you buy? Should you try to pick individual companies to invest in or should you take a more passive approach?
One popular strategy is to buy a total stock market index fund. Here’s what you need to know about using a total market index fund.
Basics of total stock market index funds
To understand total market funds, you first need to understand index funds in general.
An index fund is an investment product that tracks the performance of a certain financial index.
For example, the S&P 500 index tracks the performance of 500 of America’s largest publicly traded companies. As the stock prices of each of those 500 companies changes, those changes influence the price of the overall index.
An S&P 500 index fund is set up to track the S&P 500 index. The fund manager actually buys small stakes in all 500 of those companies. Investors can then buy shares in the S&P 500 index fund, and their investment will then match the performance of the S&P 500 index.
The S&P 500 is known as a “large cap” index fund because it invests in very large companies.
A total market index fund adds even more diversification. “Total market” means funds that aim to capture the returns of the entire stock market.
While an S&P 500 index fund might invest in 500 companies, a total market fund might invest in 4,000+ companies.
For example, the Vanguard Total Stock Market Index Fund (VTSAX) has 4,070 holdings. This means if you buy VTSAX, you technically now own very small pieces of over 4,000 companies.
Funds like VTSAX expand your investments beyond the standard large companies. They invest in small, medium and large companies, across a wide variety of industries.
Pros and cons
Invest in the whole stock market at once
No investing experience required
Your performance will match the overall performance of the stock market
No research required
You’ll never be able to beat the stock market’s returns
Can be “boring” for investors who prefer to actively research investments
Most total market funds only invest in US stocks, so you may need a second international fund if you want geographic diversification
How to buy total stock market index funds
Total market index funds can be purchased through most stockbrokers and retirement accounts.
You’ll want to look for funds with reasonable investment fees. The main thing to look for is the “expense ratio,” which is an annual fee charged by the fund manager.
Here are some of the best total stock market funds.
Vanguard Total Stock Market Index Admiral Shares (VTSAX) Number of holdings: 4,070 Expense ratio: 0.04%
Number of holdings: 3,464 Expense ratio: 0.03%
Number of holdings: 2,631 Expense ratio: 0.00% (zero fees)
Basics of individual stocks
Individual stocks are the stocks of specific companies.
An investor could buy stock in Apple (AAPL), Coca-Cola (KO) or Netflix (NFLX).
An investor could choose to invest only in one stock but this would be very risky. Most people who invest in individual stocks build a portfolio of many different companies.
For instance, they might invest in 10-20 individual companies.
This approach has higher potential returns but comes with much more risk.
If you pick the right stocks, you could earn exceptionally high returns.
If you pick the wrong stocks, you could earn very poor returns — or you could lose money. In theory, you could lose all your money if you invest in companies that end up going bankrupt.
The approach of buying individual stocks requires much more effort and research than an index fund strategy.
Investors must identify potential investments, research the companies, formulate an investment strategy, decide how much to invest and then decide when to sell that investment.
Overall, it’s a much more active strategy, compared to the passive strategy of using a total market index fund.
Pros and cons
Potential for higher returns
Can be enjoyable for those interested in finance and investing
You can still build a diversified portfolio
You can potentially “beat the stock market” by earning higher returns than the overall market
Much more risk
Much more effort required
More decision making is required: when to buy, when to sell, how much to invest, etc.
Trading costs might be higher (some brokers charge a fee for every stock transaction)
How to buy individual stocks
You can buy shares in individual stocks through any major broker and in most types of investment accounts.
Buying shares is simple. Deciding which stocks to buy is the tricky part.
Many investors align their stock selections with their investment philosophy.
A value investor might choose stocks that are “cheap” and seem undervalued. A growth investor might choose stocks that have high growth potential, like technology companies.
Ultimately, investors must do their own research about which companies to invest in.
Total stock market funds vs. individual stocks
Investing is a highly individual task. What works for you might not work for your neighbor or your coworker.
Ultimately, the decision between total stock market funds vs. individual stocks is yours to decide. To point you in the right direction, here are some things to consider.
If you don’t want to be actively involved in investment decisions, total market funds might be best. These funds offer a “set it and forget it” approach to investing.
If you enjoy researching, investing and trading stocks, individual stocks might be the best approach. This is a much more active strategy.
If you’re not sure, remember that you can always use a mix of both. For example, an investor might choose to put 90% of their investments in a total market fund, then use the remaining 10% for active investing in individual stocks. Your investing strategy never needs to be all-or-nothing.
Is credit card debt holding you back from your investing goals? Check out Tally†, an app that may help qualifying Americans get out of credit card debt faster. Tally helps qualifying applicants consolidate their credit card balances to a lower interest rate.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. Based on your credit history, the APR (which is the same as your interest rate) will be between 7.90% - 29.99% per year. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.