Index funds are remarkably popular tools for building long-term wealth. And it’s not difficult to understand why. Apart from eliminating the need to perform diligent research on individual stocks, almost all aspects of portfolio management are automated.
Index funds provide instant diversification and enable investors to mimic the returns of leading indices with next to no effort. But what sort of money can investors make by leveraging the power of these investment vehicles? And is stock picking still the better strategy despite the increased risk?
Index funds since 2019
Investors have a wide range of indices that they can choose to track. Here in the UK, most passive investor capital tends to be funnelled into either the FTSE 100 or FTSE 250. However, there are options to invest internationally, and those comfortable with a bit of currency risk may decide to follow the US S&P 500.
So if I had invested £5,000 in each of these indices back in 2019, how much money would I have today?
Starting with the FTSE 100, the index has grown by an impressive 32.4% since July 2019, including the impact of dividends. The FTSE 250 hasn’t faired as well, delivering a total return of just 19.1%. But the S&P 500’s put both indices to shame, achieving a whopping 100% over the same period!
In terms of money, a £5,000 investment in the FTSE 100 would now be worth £6,620, the FTSE 250 would be £5,955, and the S&P 500 would be £10,000. That’s quite a wide performance range, with the latter primarily benefiting from significant exposure to the technology sector.
Is stock picking better?
While the S&P 500’s performance is undeniably impressive, it remains pretty lacklustre compared to what some individual businesses have achieved. Take Nvidia (NASDAQ:NVDA) as an example. The GPU chipmaker has seen its market capitalisation grow by a whopping 2,960% over the same period. To put that into perspective, a £5,000 investment in 2019 is now worth £153,000!
Investors who saw the opportunity five years ago are undoubtedly celebrating right now. With artificial intelligence (AI) becoming an omnipresent technology, demand for the firm’s chips has skyrocketed, turning an already profitable enterprise into a global giant.
Of course, Nvidia’s a pretty exceptional story. There have been plenty of companies in the US and the UK that have fallen short of expectations. And putting such enterprises into a custom portfolio would have likely delivered weaker returns compared to index funds. Some may have even destroyed wealth.
Picking stocks isn’t a straightforward process. There are a lot of factors to consider both company-specific and at the macroeconomic level. That makes it a far more involved process that demands considerably more discipline and effort, which isn’t everyone’s cup of tea.
But, despite the increased risk and volatility, it remains my personal favourite approach to building wealth in the stock market.
