Buying ETFs vs. Picking Individual Stock
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The stock market has produced wealth for many individuals. Buying assets and holding onto them can generate compounded returns. While a few days in the stock exchange won’t result in life-changing returns, those incremental gains add up.
For instance, if you invest $10,000 and generate an annualized return of 8% over 40 years, you will end up with a $217,245 portfolio. Some investors believe they can achieve higher returns by picking the right exchange-traded funds (ETFs) and individual stocks.
This guide will explore the asset classes and the pros and cons of buying ETFs and picking stocks. It will help you better understand which investment choice is right for your long-term goals.
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What to know before you invest
Stocks and ETFs both allow you to compound your money. These assets can comfortably outperform your high-yield savings account, but they are optimal for long-term investors. Stocks and ETFs go through some volatility in the short run, but if you choose solid ETFs and corporations, your investment portfolio should grow in the long run.
Before you invest in any asset, it is important to lay out your goals and then build an investment strategy. Not everyone should buy high-flying growth stocks and ETFs. Investors who are approaching retirement and want steady cash flow from their investments may gravitate toward dividend-income ETFs and corporations with high yields. They should look for companies that pay dividends. Younger investors who have more time for their investments to pan out may want to focus on growth stocks and ETFs.
Establishing your long-term goals, risk tolerance, and other information about yourself can help you set parameters. The best investors reject many ideas before choosing the stocks and funds that align with their objectives. Once you know what you want, choosing the right stocks and ETFs becomes easier.
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Benefits of investing in individual stocks
These are some of the perks of buying individual stocks or a single company instead of relying on an ETF.
The potential to beat the market
Picking individual stocks allows investors to outperform the stock market over the long run. People who bought Nvidia five years ago and held onto their shares have seen their positions grow by more than 3,000%. Nvidia's 5-year returns are similar to the S&P 500's 40-year returns.
You can't beat the market by buying ETFs that mirror market performance. Some investors believe the stock market is inefficient and great opportunities can fall under the radar. While mega-cap tech stocks receive all the attention, many hidden companies report higher revenue and profit margins each year.
More control over your portfolio
When you buy an ETF, you don't have any control over the fund's portfolio. If you review a fund's holdings and don't like some of the positions, there isn't much you can do about it. Due to its market cap, Tesla is in a large position in ETFs that track indices like the S&P 500 and the Nasdaq Composite. The company faces heightened competition in China and has a lofty valuation. If you buy an S&P 500 ETF, you have decent exposure to Tesla, even if you don't like the stock.
However, buying individual stocks gives you full control over which stocks you buy and avoid. You can exit a position if you no longer feel confident about a stock or double down on your favorite picks.
Investors who buy individual stocks can also end up with outsized positions in companies that make up a small percentage of the S&P 500. For example, an investor who buys an S&P 500 ETF only has a 0.20% stake in Chipotle. However, an investor who is feeling bullish on Chipotle may decide to accumulate more shares until it makes up 2% of their portfolio.
Buying individual stocks allows you to hold smaller corporations as your top holdings instead of investing most of your capital in mega-cap stocks.
No additional fees
ETFs charge management fees that are reflected in the expense ratio. This ratio is equal to a percentage of your position in the ETF. An investor with $100,000 worth of an ETF with a 0.50% expense ratio will pay $500 annually, even if the fund underperforms the stock market. Passively managed ETFs that mirror stock indices have lower expense ratios.
Some of them get below 0.10%, meaning you'll barely pay anything. However, it's still an extra cost that will impact your total returns. Picking individual stocks frees you from an expense ratio. You can also save money on capital gains because some fund managers regularly buy and sell shares, which triggers short-term capital gains.
You can align your portfolio with your goals
Individual stock picking offers the customization you can't get with ETFs. If you want to invest in dividend growth stocks, you can invest in individual stocks. You can even set more parameters, such as only buying stocks with market caps between $10 billion and $50 billion that recently reported higher revenue and profit margins.
You can also decide to invest solely in the Magnificent Seven. Interestingly enough, the Roundhill Magnificent Seven ETF fulfills this premise and has a higher year-to-date return than the S&P 500 and the Nasdaq Composite.
Capitalize on opportunities as they arrive
Did the stock market overreact to an earnings report? It happens often, and dips can create buying opportunities if they are unwarranted. Most fund managers don't move quickly enough to capitalize on these short-term opportunities, and passive managers don't pounce on any of these opportunities.
Investors who pick individual stocks can position themselves to benefit from the opportunity. They can use a dollar-cost averaging strategy and invest more capital into the undervalued stock as cash arrives.
Benefits of investing in ETFs
While picking individual stocks has its advantages, you can also benefit from ETFs. These are some of the benefits of prioritizing funds over individual stocks.
You spend less time in your portfolio
It doesn't take as much time to monitor an ETF as it does to oversee dozens of stock picks. If you pick too many stocks, staying on top of them can feel like a part-time job. ETFs give you more time to focus on career growth opportunities, side hustles, and other ways to grow your income.
You don't have to be an expert
Successfully picking individual stocks requires plenty of knowledge. You have to know how to read financial documents, press releases, presentation slides, and relevant news items. You also have to know how to interpret this information and repeat this process for numerous corporations.
When you buy shares in an ETF, you leave all the research to someone else. You can buy an ETF with good historical returns and asset allocation and then wait. The stock market has an immense learning curve, while you can get the hang of ETFs within a day.
Less emotional stress
ETFs offer a hands-off approach to investing. If a stock drops by 10% after a bad earnings report, those losses get absorbed in an ETF. However, those losses are more pronounced if you are picking individual stocks.
Seeing higher losses for individual positions can lead to emotion-fueled investment decisions, especially if the stock market is experiencing sharp volatility. Investors have to think logically instead of letting their emotions guide them. Some investors can handle the pressure of owning individual stocks, but others may benefit from having an ETF instead.
Instant diversification
Some ETFs give you exposure to hundreds of publicly traded corporations. It is very difficult to accumulate many individual stocks and stay on top of your positions. You can also buy multiple ETFs to build a diversified portfolio. For instance, some investors may buy a tech ETF and then put some of their remaining capital into a dividend growth ETF.
Market returns are still good
A main draw with picking single stocks is that you can outperform the stock market. While it’s enticing to think of what your portfolio would look like if you bought Nvidia five years ago, it isn’t easy to find stocks like Nvidia, Amazon, or Apple.
Some investors may have accumulated Nvidia stock at the right time, only to have sold out of their positions too early. Emotions can cause people to make those types of decisions. However, there isn't anything wrong with market returns. The S&P 500 has increased by more than 80% over the past five years. The Nasdaq Composite has more than doubled during the same amount of time. ETFs that track these indices have performed well in the long run. Matching market returns can still help you achieve your long-term financial goals.
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Who should pick individual stocks?
Picking individual stocks is suitable for investors who want to outperform the stock market and take an active interest in reading the news, press releases, and earnings reports. Stock pickers are lifelong learners who study valuation metrics and how the most successful investors approach the stock market and craft their investing style.
Your investing style can change periodically as your long-term goals change and as you test out your strategies. Even if you pick individual stocks, you don’t have to check your portfolio every trading day. Periodically staying on top of the news and reading press releases can give you a pulse of what’s happening with your favorite positions.
However, investors who pick individual stocks have to pay closer attention during the earnings season. A corporation’s earnings report offers an up-to-date perspective of how that company is performing, which is when the share price could show volatility.
Who should buy ETFs?
ETFs are better for investors who do not want to stay on top of individual stocks, macroeconomic news, specific industries, or anything else. These investors want to do something more productive than leaving their money in a savings account.
ETFs are optimal for investors who want less stress and lower risk. These funds make more sense for beginners since a fund manager handles everything. You just have to find an ETF that follows a market index or has a stated objective that matches up with your long-term financial goals. While ETFs are great for beginners, they are also useful for seasoned investors. Some individuals with many years of experience may want to take a break and spend less time in their portfolios. ETFs offer less stress and prevent an experienced investor’s emotions from getting in the way of good decision-making.
Can you invest in both?
You can choose between individual stocks and ETFs, but investing in both investment vehicles is possible. Buying shares in a diversified ETF can simplify offer portfolio diversification. You can then concentrate on a few individual stocks, knowing you have an ETF with hundreds of holdings. Investors can also invest in an ETF that focuses on a specific sector and use their individual picks to diversify into additional categories. For instance, some investors seeking exposure to artificial intelligence stocks may want to look at the iShares Semiconductor ETF.
Nvidia is the fund’s top position, and it’s filled with other semiconductor stocks that benefit from the rising demand for AI. An investor can buy shares in this ETF instead of individual AI stocks. Focusing on this fund will then give you the flexibility to allocate your capital across holdings that are less correlated with artificial intelligence.
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The bottom line
Investing in the stock market can get you closer to your long-term financial goals. You can choose from many stocks and ETFs, but it's important to assess if you want to actively follow the markets or be a passive investor. ETF investing is better for passive investors, while active investors who want to outperform the stock market can benefit from picking individual stocks. You can also have a mix of stocks and ETFs in your portfolio. It’s not always necessary to have one while not having the other.
Investors should assess their long-term financial goals, determine how much time they want to spend in their portfolios, and learn about stock trading. Once you know more about yourself and what you want to achieve, you will be able to make the right decision for your finances. If you need help, consult a financial advisor for investment advice based on your personal finance goals and risk appetite.
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Writer
Marc Guberti is a business freelance writer who specializes in personal finance, digital marketing, and entrepreneurship. His award-winning book "Content Marketing Secrets" teaches readers how to create, promote and optimize content for growth and revenue. Marc also hosts the "Breakthrough Success Podcast," where listeners learn how to master content marketing and get more clients.
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