Q: Index funds or stocks?

A: There are good reasons to invest in index funds as opposed to individual stocks or actively managed mutual funds. In fact, famed investor Warren Buffett has even gone so far to say that low-cost index funds are the best investment most Americans can make.

One good reason is diversification. Even if you have 15 to 20 individual stocks in your portfolio, one of them collapsing could cost you. But if you buy a Standard & Poor’s 500 index fund, your investment will depend on 500 different stocks, only three of which account for more than 2% of the index ( by weight).

Mutual funds can accomplish the same thing but at a much greater cost. Many actively man- aged funds have expense ratios of 1% or more. In contrast, the Vanguard S&P 500 ETF, for example, has an expense ratio of 0.04% — for every $10,000 you have invested, your annual fees and fund expenses will be just $4.

In fairness, mutual fund fees can be worth it if they are justified by the fund’s performance. For example, Dodge & Cox Stock Fund charges a 0.52% expense ratio but has consistently outperformed the market for decades, even inclusive of its fees.

Buffett wasn’t saying people who have the knowledge, time and desire to research and choose individual stocks or mutual funds shouldn’t do it. Rather, he’s pointing out most Americans don’t have these characteristics, so index funds are preferable to uneducated stock-picking or, in most cases, choosing actively managed mutual funds.