The above statement is true about a diversified portfolio — the S&P 500, which holds 500 of the largest stocks in the U.S., has historically returned an average of around 7 percent annually, when you factor in reinvested dividends and adjust for inflation. That means if you invested $1,000 30 years ago, you could have around $7,600 today.
That long-term growth would have happened despite several bear markets, which you can't avoid as an investor. What you can avoid is the risk that comes from an undiversified portfolio. Individual stocks frequently fizzle to a lifetime loss of 100 percent, according to a recent working paperby Arizona State University professor Hendrik Bessembinder.
If you throw all of your money into one company, you're banking on success that can quickly be halted by regulatory issues, poor leadership or an E. coli outbreak (yes, we're talking about Chipotle). To smooth out that company-specific risk, investors diversify by pooling multiple stocks together, balancing out the inevitable losers and eliminating the risk that one company's contaminated beef will wipe out your entire portfolio.
But building a diversified portfolio of individual stocks takes a lot of time, patience and research. The alternative is the aforementioned ETF or index fund. These hold a basket of investments, so you're automatically diversified. An S&P 500 ETF, for example, would aim to mirror the performance of the S&P 500 by investing in the 500 companies in that index.
The good news is you can combine individual stocks and funds in a single portfolio. One suggestion: Dedicate 10% or less of your portfolio to selecting a few stocks you believe in, and put the rest into index funds.
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This article originally appeared on NerdWallet.