Why Picking Individual Stocks May Be a Better Move Right Now Than Buying Index Funds and ETFs

Many long-term investors have become accustomed to just buying index funds and exchange-traded funds (ETFs) that provide broad exposure to a mix of stocks and simply hanging on for the long haul. But this isn't a perfect strategy. There are some serious issues with buying some of the most popular funds on the market right now. With valuations rising and Space Exploration Technologies (NASDAQ: SPCX), also known as SpaceX, being added to many of them, they are going to get a whole lot more expensive in the near future.

Investing in index funds and ETFs could be riskier than normal these days, and here's why picking individual stocks may be the way to go right now.

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Quicker access to IPOs could do more harm than good

SpaceX recently went public at an astronomical valuation; its market cap is around $2.1 trillion today, making it one of the most valuable stocks in the world. But it's also unprofitable and trades at more than 100 times revenue, making it among the most egregiously priced stocks you can find right now.

The Nasdaq recently made changes that make it easier for IPOs to be added to the Nasdaq-100 index, a collection of the most valuable non-financial stocks on the exchange. SpaceX is set to be added to the index as early as July. Other IPOs, including OpenAI and Anthropic, may also follow suit when they go public in the near future.

While this may sound great for growth investors, these are also the types of companies that are likely to have high valuations, not due to their strong underlying fundamentals, but rather the hype around their businesses. This makes investing in a fund such as the Invesco QQQ Trust (NASDAQ: QQQ), which tracks the Nasdaq-100, a bit risky. The Nasdaq is already full of high-priced stocks, and adding SpaceX and other highly valued IPOs may make the situation worse, not better.

Picking individual stocks may be the best option today

If you're investing in individual stocks, you know which companies are in your portfolio. With a broad fund, however, you might get exposure to a whole bunch of stocks you don't really want. And if the fund rebalances over time, such as the Invesco fund, it can also change. Unless you're staying on top of such developments, you may not realize which stocks are impacting your portfolio.

By going with individual stocks, you won't have to wonder. Investing in many types of growth stocks can be a good way to spread out your risk while still setting yourself up for long-term success. And with minimal and in some cases no commission fees, there's no longer a high cost to deter you from owning a broad mix of stocks.

David Jagielski, CPA has no position in any of the stocks mentioned. The Motley Fool recommends Nasdaq. The Motley Fool has a disclosure policy.