Should Investing Beginners Start With Index Funds or Individual Stocks?

At The Motley Fool, we believe the individual investor can beat the market. But is that the best target for a novice to start with?

In this segment of the MarketFoolery podcast -- an all-mailbag episode -- host Chris Hill and Motley Fool senior analyst Bill Barker respond to a listener who is preparing to start investing and trying to decide between picking stocks or buying index funds. And while it might surprise some people who recognize the Fool's inherent tilt toward a stock-picking worldview, Barker and Hill in this case lean toward index funds as your early holdings. Listen in to hear why.

A full transcript follows the video.

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This video was recorded on July 2, 2018.

Chris Hill: Question from Roy Ben Daniel in Tel Aviv -- going international right off the bat. "Do you have a word of advice for the beginning investor -- investing in index funds or individual companies? Thanks."

Great question, and I think one of those questions that a lot of beginning investors ask. Not just, how do I get started, but, where do I start? I think, in general, all things being equal, we're fans right off the bat of the index fund, particularly if you can get it at a low cost, which you should be able to do.

Bill Barker: Right. Low-cost has gotten lower and lower and lower with competition. The index fund or index funds ten or 20 years ago largely would have translated into the S&P 500 being an index, and the one that more money was aggregated around in the funds space. There are a lot of index funds now with the popularity of index funds. Really, that should be the popularity of low-cost investing. A lot of people have created more and more refined, and sometimes very specific, indices. I think that the S&P 500 index fund -- or, if you want to go broader, the Vanguard Total Market index fund -- are great places, fantastic places to start, because they give you broad diversification and low cost. Those are two great things when you're a beginning investor.

Individual stocks, you can make a lot more mistakes. Risk and reward is the equation there. You're taking a lot more risk on if you're just buying one or two or three stocks. It might be more fun, it might keep you more focused on what your investment is doing, but it also carries with it the risk that you are not properly diversified.

Hill: Ultimately, for anyone who's interested in investing in individual companies, we're fans of, get to the point, when it is financially feasible, where you have a diversified portfolio. So, not just the anchor of an index fund, whether it's a Total Market or an S&P 500, that sort of thing, but, you have a portfolio built out with, ideally, north of ten stocks, I would say.

Barker: Yes. If you're an individual investor -- sorry, a beginning investor, learn about yourself.

Hill: Only individual investors are listening right now.

Barker: There's not a party. Are there listening parties for this podcast, do you suppose?

Hill: No. And there are not institutional investors, there aren't, like, someone is playing this Market Foolery episode in a conference room with a dozen or so analysts on Wall Street listening at once.

Barker: That's sad.

Hill: [laughs] It's a couple of things, I don't think sad is on the list. Sorry, I interrupted you.

Barker: You did. I think we were trying to provide useful advice, rather than these tangents that you always insist on going on when I show up.

Hill: Sorry. Well, it is part of the official Market Foolery Twitter feed description --occasional tangents. For anyone out there who's like, "I just don't like the tangents," that's fine, just know that that's baked into the description of this show.

Barker: Right. So, keep your costs low, be diversified. When you're a new investor, that's a little harder to do than when you have a little bit more experience. You can get excited by seeing one or two stocks go up or frightened by seeing one or two stocks go down. Know yourself when you're investing.

If you have, say, most of your money in an index fund, and you use part of your money to get more lessons, both about yourself and about the market through buying individual stocks -- certainly our site, our newsletters, various things, help individual investors learn about potential good opportunities on individual stocks. I think that's more interesting than following the broad market, but most investors are going to benefit from just having a broad market index fund and buying and holding for decades.

Bill Barker has no position in any of the stocks mentioned. Chris Hill has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Twitter. The Motley Fool has a disclosure policy.