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Investor’s column: Individual stocks or exchange traded funds? Try a balanced approach

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I have read several articles during the past few weeks regarding which is best, individual stocks or exchange traded funds (ETFs).

Individual stocks are the least-expensive securities to hold in an account. There are no ongoing “asset” charges as with other investments such as mutual funds and ETFs. There is no debating this fact. They are, from that prospective, the least expensive.

Exchange traded funds have ongoing asset charges. These can range from zero basis points for large indexes such as the S&P 500 stock index fund up to several hundred plus basis points for smaller focused ones.

One hundred basis points is equal to one percentage point. Keeping with the larger, lower-cost ETF’s is recommended. It is those that we will continue to discuss versus individual stocks and bonds.

Fortunately, none of the articles I read tried to defend actively managed mutual funds. They lose in most cases. With expenses and performance being a negative factor. These funds have been losing assets to ETF’s for many years.

Every year, early on it is ”going to be the year of the stock picker” over non actively managed accounts. I have been waiting for that to happen for ... forever. And how would one identify the outperformer before it outperformed?

The real debate is between individual stocks versus ETFs. Is one way better than the others? I propose they do not have to be excluding one for the other.

Mike Doll.jpg
Michael T. Doll is an investment adviser with the Longboat Key Financial Group.

Buying individual stocks when starting with a large sum of money can make sense. But it can be a challenge when buying in a monthly or other systematic plan. What to buy first? How about the risk tolerance of the investor?

Most of my clients and others don’t care much about individual stocks. They want their money invested in a safe and diversified manner — period. They don’t wake up every day and turn on a financial channel. After all, most are retired or about to be a retiree.

Smart money — think large pensions plans in addition to keeping costs low — often takes a top-down approach. This makes, in my opinion, the best use of both individual stocks and ETFs.

Here’s how that might look. First, cover the broad market using an ETF such as the S&P 500 or even more so the Total Market index. Then in smaller amounts, add certain sectors that seem attractive to the portfolio. The S&P 500 has 11 sectors. By adding one or more of these smaller sectors, one now has the ability to outperform the overall market.

A slight aside here: Yes, if one only buys an index fund, he will never outperform the market it represents because of cost involved to own that index. With the S&P total market index (includes the reinvestment of dividends) closing up 19.8 percent recently, to receive a slightly less return because of reasonable cost would not be a problem. You would still have a nice return.

In this manner, boring works for many investors. Trying to outperform the markets using active management is fools play. Average is good — very good — for most investors.

The next step if one wants the opportunity for greater gains (or losses) would be adding a managed mutual funds that focuses on the sector one wants to overweight. We want it to own only a handful of stocks in that sector. Not the entire sector as we already own it with the ETFs.

We can continue to ramp up the sector by adding individual stocks. We now own the broad sector index, an actively managed focus fund and individual stocks in that sector. If one really wanted to up their exposure to that sector, he or she could purchase options as well. Buying options is risky and not something I would recommend.

In reality, what do I see? I see little individual stock portfolios. I see a little stock here and there. I do see a lot of broad-based portfolios using more ETFs not traditional actively traded mutual funds. Sorry to say I still have investors coming to me with those funds.

Individual stocks are great, particularly the larger well-established companies. They should be long-term investments.

Combining individual stocks with a portfolio of broad-based ETFs make the most sense to me. Stocks and ETFs can work together.

Michael T. Doll, an investment adviser with the Longboat Key Financial Group, can be reached at 941-896-2473 or michaeltdoll@longboatkeyfinancial.com.

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