Inflation is stuck in overdrive, a potential recession is hanging over our heads, and the Dow Jones Industrial Average DJIA, -0,73 percent and S&P 500 SPX, -0,84 percent have both taken a dive this year. Many people are feeling understandably jittery about their finances.
Some may be looking at their investments through a lens of uncertainty, wondering if they should change things up. One perennial question some have: is it better to pick and buy individual stocks or buy shares of an exchange-traded fund (ETF)?
Why it matters
Investing is one way Americans build wealth. The choices we make in this arena can have serious long-term consequences — for example, on the amount of money we are able to save for retirement.
Picking individual stocks lets investors suss out companies and decide to buy a piece of one that they think is going to do well. ETFs, on the other hand, can let investors get a piece of several companies at once. An ETF is a basket of securities; it can include stocks, bonds, commodities, currency. They’re similar to mutual funds because they’re made up of groups of securities. But ETFs differ from mutual funds because their shares can be traded throughout the trading day, whereas mutual funds trade at the end of the day.
ETFs tend to have lower fees than mutual funds, though “the gap is closing” according to Investopedia, and ETFs are also typically more tax-efficient than mutual funds because they tend to generate fewer “taxable events,” says TurboTax.
Why put all your eggs in one basket when you can have an entire basket of stocks? Who has the time to research and then monitor individual companies? Hasn’t history shown that stock pickers underperform against index investing?
“There’s so much research on how the average investor just has really bad timing, because they get caught up in euphoria,” said Greg Plechner, a partner and wealth manager at Greenspring Advisors in Paramus, N.J. “They want to buy Peloton PTON, -2.09%, they want to buy Tesla TSLA, -2.02%, and when the market turns they’re the ones left holding the bag.” ETFs give you immediate diversification, and can mitigate the pain of holding just one or two stocks directly, he said.
They’re also very efficient. When people think of the stock market these days, they typically think of the S&P 500, or the 500 largest publicly-traded companies in the US. If you wanted to invest in all of those companies, sure, you could theoretically buy, or ask your financial adviser to buy, every single one of those stocks, Plechner said.
But that wouldn’t be efficient.
“By having an ETF, you can make one transaction and effectively get the same outcome as the 500 individual buy orders that you’d have to place,” Plechner noted.
Some people argue that investors have more control when they own individual stocks, Plechner said. That’s true, but that control comes with more risk. For example, if you buy Twitter TWTR shares because you think Elon Musk’s acquisition deal is going to go through, you could be rewarded with a good-sized return, but if you’re wrong, you’ll take a good-sized loss.
“When you invest in ETFs, you eliminate single stock risk,” Plechner said.
If you invest in an ETF, and one company in the fund starts lagging — say a company like Peloton, which this time last year was at US$96 and traded most recently at less than US$8 — you’re not going to get wiped out by having too much exposure to any one stock, he said. “In investing that’s something that is desirable, that one problem investment doesn’t take down all of your holdings,” Plechner said.
ETFs can also save investors time and effort. They provide “broad exposure to market indices and/or sectors for those investors who do not have the time, desire, and/or expertise to conduct fundamental research on their own,” said Steven K. Wilkes, a chartered financial analyst with Hutchinson Capital Management, a fee-only financial planning and investment management firm in San Rafael, Calif.
ETFs also allow investors to diversify nimbly, said David Marshall, ETF Model Portfolio Strategist at State Street Global Advisors. “When you think about using ETFs the first thing to keep in mind is how efficient a vehicle they are,” Marshall told MarketWatch.
They marry the benefits of mutual funds (by providing a portfolio) with the benefits of stocks, because they can be traded at any time, he said. “If you want to change the complexion of your portfolio, you can do so with the right ETF. I liken them to surgical instruments,” Marshall said.
Is my verdict best for you?
On the other hand, while some ETFs are index funds that track the broader market, some can be very narrowly focused, which can make them as potentially risky as owning just a few individual stocks, some observers say. And the ability to trade frequently isn’t necessarily a good thing.
Some thematic ETFs track societal trends: one focuses on the obesity epidemic, another tracks stocks that get the most buzz on social media. There are even single-stock ETFs, which some have called “day-trading tools” that should only be used by sophisticated investors. There are plans for an inverse ETF that will bet against the stock picks of CNBC’s “Mad Money” host Jim Cramer.
Indulge too much in these quirky ETFs, and your investment portfolio runs the risk of turning from a well-balanced meal into a cheat day where you’re binge-eating fried chicken, MarketWatch columnist Mitch Tuchman previously wrote.
“Just like individual stocks, there are thousands of ETFs in the investment universe so making investment decisions may not be as simple and straightforward as perceived,” Wilkes said.
One argument in favor of stock-picking: some people revel in making investment decisions. If you’re reading MarketWatch, there’s a better than average chance that you follow the markets and companies pretty closely. If you like to pore over earnings reports and 10-Ks, owning individual stocks could be a good option, because you may prefer being a highly engaged investor. As the Motley Fool pointed out, one reason to pick your own stocks is that it teaches you about business, which makes you into a better investor.
But what is a “better” investor? Warren Buffett famously said, “You don’t have to be right about thousands and thousands and thousands of companies, you only have to be right about a couple.” That observation may give you the idea that just a couple great stock picks will send you on the path to billions. But Buffett’s wealth has come more from the longevity of his investments than from his prowess as an “oracle.” — Market Watch