Invest and prosper

I think that most beginning investors should start by investing in an index fund. There are several reasons for this:

1. Diversification - it is not easy to assemble a well-diversified portfolio by collecting individual stocks. An index fund, on the other hand, is already extremely diversified. For instance, Vanguard 500 Index fund (VFINX) tracks the persormance of the S&P 500 index, which includes - you guessed it - 500 stocks. Standard & Poor has already done the job of picking 500 excellent large US companies, so you wouldn’t have to.
2. Tax efficiency - index funds very rarely sell stock; companies do not get kicked out of S&P 500 too often. Therefore, the chance that an index fund will distribute capital gains to you is very small. On the other hand, some actively managed mutual funds will sell stock often; if they sell stocks at a profit, the capital gains will be distributed to you, sticking you with a tax bill.
3. Ease of administration - this one is easy. Watching an index fund is not as labor-intensive as watching a portfolio of 10 different stocks. In addition, you do not have to follow an index fund as closely. The net result is that you save time, effort and possibly money that your occasional lapses in attention could cost you.
4. Low transaction costs - if you buy a number of shares of an index fund, you pay one commission charge. If you buy 10 different stocks, you pay 10 commission charges. Enough said.
5. Returns - Only one in three actively managed stock funds in operation since 1976 has beaten the Vanguard 500. You can be in the top third of the returns of all professional money managers by simply owning an S&P 500 index fund!
6. Low volatility - an index fund is extremely unlikely to plummet in value with the same speed than any individual stock or even a 5-10 stock portfolio. Sure, it can’t increase in value with the same speed either - but to most people, losing money quickly is of more concern than missing out on making even more money.