Should you put your money in individual stocks, or are ETFs a better choice? So many investment options to choose from!
Many new investors might think that individual stocks will grow their money fast. But that is not always the case, and it depends on many factors. This post will talk about the pros and cons of individual stocks vs. ETFs.
At the end of this post, you have all the important information you need to make good investment decisions for your future.
Key Takeaways
- ETFs are great for broad exposure to the market, a sector, or an industry.
- ETFs do not require much of your time.
- Stock Picking is difficult and can take a lot of your time.
- Picking the right stocks can get you outsized returns.
Important Note
I wrote this article from the perspective of a long-term investor. I want to ensure that my readers get information that is based on my investment philosophy when it comes to stock investment:
#1 Buy and hold Stocks for 5+ years
#2 Have at least 25 Stocks
#3 Don’t overreact on short-term news
#4 Reinvest into your winners
What Is An ETF?
ETF stands for Exchange-Traded Fund. From your investor perspective, it works just like an individual stock. You can buy and sell them during a normal trading day.
Behind the scenes, ETFs are a collection of companies or individual stocks. Every ETF is structured a bit differently. Some ETFs invest in a specific industry, and others are spread more broadly.
In total, there are over 3000 ETFs listed on the US stock market at the time of writing. There is an ETF for almost anything.
Each ETF provides a summary prospectus document outlining its goals, structure, fees, and more. Make sure to read that prospectus to understand the ETF before investing in it.
Active and Passive ETFs
In the world of ETFs, you differentiate between actively and passively managed ETFs. Think about it like this: Some ETFs have an active research team taking care of the companies in the ETF. Passively managed ETFs have a passive strategy and diversification that does not need anyone to monitor the investments closely. It is a more automated process and, thus, more cost-effective.
ETF Fees
Speaking of which, ETFs come with management fees called the expense ratio you will pay when investing in them. This is the money you pay for not having to put in your own research time. Traditionally, active ETFs have a higher fee than passively managed ETFs.
It is important to take these fees into account when making investment decisions. They are part of the total cost calculation.
Is Stock Picking For You?
Let’s be real: Picking the next Amazon or Apple is tough. And holding it through all the ups and downs along the way is even tougher. If you had invested in Amazon initially, there would have been many downturns of 70% or more. It is easy to see in hindsight that Amazon was a great investment. But seeing and believing it along the way is an entirely different story.
Related Post: Income vs. Value vs. Growth Stocks, which is better?
Just because individual securities can provide a better return doesn’t mean that you should invest in them. The level of detail you need to look at is one of the key differences between individual stocks vs. ETFs. This is what you are signing up for as a stock investor.
Related Post: What Is FOMO In Stock Investment And How To Avoid It
I always say that you should think about your stocks as a real ownership of a portion of the company. You should feel good about that part ownership.
You Only Need A Few Winners
If you look at an investment portfolio of individual stocks, many companies will turn out to be losers. Only a small portion of your individual stocks will turn out to be incredible investments. But that is all it needs. A stock can only go down to 0%, but there is no upper limit. It will be the few winners who will carry all the other losers of your portfolio.
Higher Portfolio Volatility
Investing in individual stocks comes with another important factor to consider: volatility. Your portfolio can move up and down much more than the overall market does, depending on the market conditions. This can be stressful for some investors. You need to ask yourself how you’d feel about a drop of +50% in your portfolio. Is that something that makes you feel anxious, or are you fine with that?
Researching Individual Stocks
If you invest in an individual stock, you are signing up to follow that company. To ensure your money is invested in the right place, you will need to do your own research.
I’ve spent much time doing exactly that in my investment journey and will do it for a long time. To make my life easier, I’ve created my own little framework. It allows me to look at different important angles for every good company.
“A truly great business must have an enduring ‘moat’ that protects excellent returns on invested capital.” – Warren Buffett
You Aren’t Familiar With Every Sector Or Industry
As a general rule of thumb, you should only invest in what you understand. This rule is important when investing in individual stocks.
ETFs can expose you to sectors or industries you don’t fully understand at a much lower risk. Not everyone is an expert at understanding Biotech companies. Nonetheless, if you want exposure to that industry, you can pick an ETF that invests in a broad basket of biotech companies.
ETFs can reduce your overall risk a lot and allow you to capitalize on the developments and advancements in that industry. You will not have to follow individual stocks or learn all about an industry before investing.
Industries Where ETFs Are A Better Option
I think it is fair to say that some industries are easier to understand than others. And then some industries are generally riskier than others, too.
Take, for example, companies in the pharmaceutical or biotech industries. Their success largely depends on FDA approvals for drugs, results of clinical trials, etc. You would be forgiven if you don’t have enough insights to know which company will most likely pass these high bars. There are entire services whose sole purpose is to track the news around FDA approvals.
If you are not up for that kind of challenge but still want to get some exposure in your portfolio, an ETF is one of the best financial products for you. It frees you up from the tedious task of closely following too many individual companies.
Maybe You Need A Hands-Off Investing Strategy
Picking individual stocks is definitely not something for everybody. Some investors prefer to invest their money in simpler ways. They don’t want to stress out about a single company and instead prefer a hands-off approach.
Exchange-traded funds, index funds, and mutual funds are asset classes that can provide such a strategy for you. Numerous ETFs available have a broad diversification and largely track the overall market performance.
Tracking the market is a perfectly fine strategy and has been very successful in growing your wealth in the long term. It requires almost no time and can be largely automated using a single ETF like the SPDR S&P 500 ETF Trust or the iShares Core S&P 500 ETF. These ETFs are a very good option, offering a high diversification in the 500 largest companies listed on the stock exchange in the United States.
With more specialized ETFs, you also have the chance to beat the market if that is something you are trying to do. An example would be an ETF that aims to provide a high dividend income. Remember that past performance is not a good indicator of future returns.
Final Thoughts – Individual Stocks Vs. ETFs: When To Buy What?
ETFs present a way to diversify your investment into a bigger basket of stocks while making the process as easy as it can be. They are a great choice to get exposure to industries or sectors you don’t understand well enough. For investors who prefer a simple investment strategy, ETFs are also a great choice.
Investing in individual stocks is an investment decision you should consider ahead of time. It is for more professional investors who have a higher risk tolerance and want to beat the market.
A lot of research goes into picking good companies that can produce higher returns. And it doesn’t stop there. Once you start investing, you need to follow the company for as long as you are invested in it. Making sure that you have a diversified portfolio is one of the most important factors.
Making sure that you have a diversified portfolio is one of the most important factors.
This is what it takes to increase your odds of success in the long term.
The question of individual stocks vs. ETFs largely boils down to your risk tolerance, your investment objectives, and your investment strategies. Whatever choice you make in your brokerage account should be based on your financial goals.
Disclaimer: The information in this blog post should not be considered investment advice or a replacement thereof. They are solely provided for informational purposes. Please consult with a financial advisor for any specific questions on your financial situation. Remember that past performance is not a good indicator of future returns. Also, none of the mentioned stocks are to be understood as recommendations. Don’t buy yourself something solely based on what you read here.
You should talk to a financial advisor and tax professional if your financial situation becomes more complex or you are in need of help with your financial planning. Finding a good financial advisor is not easy. I recommend the Garrett Planning Network, the National Association of Personal Financial Advisors (NAPFA), and the XY Planning Network. These networks can get you in contact with a fee-only advisor. No matter how much money we are talking about, it will not change your costs.
