Is it better to build your investment portfolio by first buying a hot growth stock or by buying an index fund?
Many investors start their stock buying journey by making an initial investment in something like an index fund or in some popular company, Tesla ( TSLA 4.68%) for example. But which one is the better option? The answer really depends on your personality and goals, but each option has its merits. With either option, you should make sure that you know what you’re getting into before making a decision. The case for Tesla
Tesla stock has a few things working in its favor. For instance, it’s an individual stock and that means it has different characteristics from market indexes. Image source: Getty Images. In a normal market, the S&P 500 won’t generally match the upside potential of a growth stock like Tesla. For instance, Tesla’s first-quarter revenue jumped more than 80% year over year, with production and unit shipments rising nearly 70%. Sales for stocks in the S&P 500 when averaged out don’t grow at rates like that. At best, total revenue for market indexes might modestly outpace the economy in general.
This elevated growth translates to increased returns, which sparks outsized interest from investors. Since Tesla’s IPO in 2010, the stock price is up nearly 16,000%. Meanwhile, the S&P 500 is up about 380% over the same time frame. That’s a great return for the index, but the two obviously aren’t comparable. If you’re looking to ride an investment to the moon, an individual stock is the way to go — as long as it’s the right individual stock.
There are other benefits that individual stocks can bring for first-time investors. In many ways, your first investment is a learning experience rather than a major financial decision. It’s a bit easier to track an individual stock and become engaged as its story unfolds.
Investors can read the news whenever the stock moves substantially to figure out what’s driving the price change. It’s also helpful to read quarterly and annual reports. By thumbing through a 10-K , investors can get a sense for the accounting and financial analysis involved in stock picking. Listening to the analyst question portion of the quarterly earnings conference calls can be really informative too because it will illustrate the ways that Wall Street approaches investment analysis.
First-time investors can also keep track of relevant financial metrics related to valuation, growth, operating efficiency, and financial health. Most of those learning events aren’t really applicable when applied to whole indexes.
Tesla also brings some unique educational value to new investors. The company is a case study in disruption, as it came in and displaced the incumbents of an established global industry. It’s still well behind its rivals in terms of production volume, but it’s by far the largest in terms of market cap.
The electric vehicle company can also teach investors about the behavior of growth stocks across market cycles. The stock soared during the pandemic rally, but it’s been crushed year to date — even though the company’s financial results have been positive overall.
By following Tesla, new investors can learn a lot about equity research, valuation, and market dynamics. These lessons are great building blocks that can be applied to investments moving forward. The case for the S&P 500
Index investing won’t provide the same experience or upside potential, but an exchange-traded fund based on the S&P 500 will be much more stable overall. The stocks in the S&P 500 are more diversified, and it’s not nearly as volatile as Tesla’s stock. By investing in the whole market, you aren’t making a simple bet on one company’s performance.
All sorts of unexpected issues can pop up and threaten a business, from competition to regulation. Tesla might seem unstoppable right now, but investors thought the same about Blackberry , Yahoo!, Blockbuster, and countless other industry leaders that ended up not living up to expectations. Crazy things can happen.
Investors who can’t handle some volatility should also avoid loading up on one stock. Tesla’s beta is above 2, which means that the stock’s movements up and down are double that of the S&P 500. This is especially relevant in the midst of our current market downturn. If you’re going to react negatively when your investment account values fall, it’s going to be even worse with a single high-beta stock.
Investing in the whole S&P 500 won’t teach you as much about the developments of individual stocks, but it can be more informative about overall market […]
source Tesla vs. the S&P 500: Which Is the Better First Investment?