Pitching Money At ETFs Vs. Methodically Picking Out Stocks

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Investing in the stock market is a fantastic way to build wealth. Likewise, building wealth is a crucial step towards financial freedom. According to Forbes, 9 out of 10 households who earn over $100,000 have money in the stock market. “The market will always go up.” It is also well known that holding for the long run is proven to be more profitable than day trading. “Less than 1% of day traders can profit net of fees.” But is it better to buy index funds/ETFs or to choose individual stocks?

What is a Stock?

What is an individual stock? A stock is a small piece of a company that is available for the public to purchase. You can buy an Apple stock (AAPL) on a publicly traded stock-exchange right now and own a little piece of the company. What this means is that if the company does well, and/or more people buy the stock, the price of the stock you own will go up and you can sell for a profit.

BUT, if the company stock you bought trades down and declines, you could lose money by selling. Some companies like Nortel even go bankrupt. In that case, you wouldn’t get any of your money back.

Some stocks that have had some incredible past performance are:

  • Coca-Cola (KO): +8,000% total-return
  • Microsoft (MSFT): +280,000% total-return
  • Apple (AAPL): +140,000% total-return

If you had bought $100 worth of Coca-Cola stock in 1981, you’d have more than $8000 today! Talk about stock prices rising!

What is an ETF?

What is an ETF? Well, an ETF is essentially a basket of different stocks and securities from different companies. Otherwise known as an “exchange traded fund”, most ETFs fall into a certain category. For example, SPY is the ticker of an ETF and it tracks the top 500 companies in the United States. Another one is VGT, which tracks some of the top technology companies in the States. The diversified portfolio nature of ETFs means that if some companies within the ETF do poorly, you can still make a profit if other companies within the ETF do well.

Despite all being “ETFs”, there are a LOT of different options within the ETF industry. Some are actively managed by a fund manager, while others are passively managed by a set of algorithms. Some invest only in large-cap (big) companies, while others exclusively buy small-cap stocks. Finally, some focus on stocks in developed markets (like the US) while others focus on buying stocks in emerging markets (like Brazil). Regardless, all ETFs will offer you an easy way to build a highly diversified portfolio.

Some popular ETFs are:

  • SPDR Dow Jones Industrial Average ETF (DIA): +300% total-return
  • Invesco QQQ ETF Nasdaq (QQQ): +500% total-return
  • SPDR S&P 500 ETF (SPY): +900% total-return

So how does an index-fund or ETF differ from a stock?

Stocks or ETFs?

ETF Pros:

  • Extremely diversified (you have the ability to own a whole bunch of companies at once)
  • Less volatility (usually)
  • Almost always goes up over long periods of time
  • Usually a lower expense ratio (it’s cheaper to pay the low expense ratio for an ETF than pay the commission on a whole bunch of stock trades)

ETF Cons:

  • Not a high chance for massive growth quickly (the downside of diversification)
  • Lower dividend payout than some companies

Individual Stock Pros:

  • Chance for massive growth very quickly (Tesla is up 389% in the past year vs. SPY is up 8%)
  • Could have higher dividend payout (a lot of banks have a dividend of 3%-5% whereas SPY is 1.5%)
  • Easier to research one company than to research a whole bunch of them
  • Lots and lots of variety (all publicly traded companies are available for your choosing)

Individual Stock Cons:

  • Even the biggest companies can drop a lot or go bankrupt (Nortel, General Electric, Enron)
  • Lots of potential volatility
  • More exposure to news and world events (movie theatres when COVID hit)

Similarities Between Stocks and ETFs

Both stocks and ETFs have the same tax implications. When you make money in the form of dividends from either one, you will get taxed by the IRS (or CRA if you’re in Canada). Likewise, you will need to pay the same capital gains tax on your profits from both stocks and ETFs.

Another similarity is that both stocks and ETFs can provide you with a source of passive income. There are a number of high-dividend stocks out there that could potentially provide you with similar stability to an ETF.

Put More Money in ETFs

easter eggs; Stocks or ETFs
Stocks or ETFs

Imagine you need to pick eggs from a farmer to then resell. Some eggs are golden and can be sold for a lot, while some eggs are rotten and can’t be sold at all. The farmer presents you with the choice to buy a whole carton of 24 eggs for $48 or you can pick out one egg and buy it for $2. By picking the one egg, you have a chance to make huge profits if it turns out to be golden. But, if it is rotten, you will make nothing. By choosing the basket, even if some eggs are rotten, as long as most are ok, you can still make a decent profit.

Individual stocks are like the individual egg, and ETFs/index funds are like the basket.

For long-term growth, investing in a basket of stocks is the way to go. There have been 15 recessions in the past 100 years, and even though the stock market has dropped by more than 50% on some occasions, it has always recovered and gone up afterwards.

Warren Buffett, arguably the greatest investor of all time, has stated that the best thing for most investors to do is to buy ETFs and index funds that track the S&P 500 (SPY). In fact, the S&P 500 has actually beaten Warren Buffett’s portfolio over the last 10 years. Buffett has instructed that 90% of his money be invested in index funds after he dies.

If the greatest investor of all time with a net worth of over $80 billion is having trouble beating SPY, I don’t think I stand a very good chance. Not only that but nowadays, there are huge Quant funds backed by very smart people and even smarter computers which collectively make stock picks. Those are the companies you are competing with when you try trading individual stocks.

Allocation of Money

This doesn’t mean don’t pick stocks. If there is a company that you really understand and have a lot of faith in, by all means, invest in it. But, to truly understand a company, you have to go beyond the financial statements and really analyze the fundamentals of the business and what they do.

The time and effort that that takes coupled with the chance that something completely out of your control (ahem-COVID) might happen and could kill the company, is far outweighed by the relative ease of purchasing and holding an ETF.

There is one downside. You might miss out on some growth opportunities in the short term. However, as Warren Buffet says: “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” Investing is a long-term game with optimal time horizons of 10, 20, 30 years. Those chasing short term returns are traders, not investors.

My portfolio consists of 80% ETFs that track the S&P 500, 10% tech ETFs, and 10% individual picks. The tech ETFs are for the inner nerd in me, and the individual picks are to satisfy my ego which secretly thinks that I might be able to beat the market. Odds are in a few years SPY will beat out my individual picks and I’ll switch over entirely, but there’s still a chance 😉

So what are you waiting for? Get out there and start investing with your brokerage! You’d be surprised at what time and some money in the stock market can do for you.

Thanks for reading through Stocks or ETFs and thank you for following along! If you’re a Canadian Student, check out the Ultimate Canadian Student’s Guide to Personal Finance! To learn more about me, head over to this link here. Also if you’re interested in dividend investing, you’ll love this list of Canadian Dividend Aristocrats. If you want to get exclusive updates and tips, drop your email in the “get updates” box (might have to scroll up a bit.) Let me know your thoughts and suggestions in the comments!