Showdown: ETF vs Individual Stock Portfolio

10 October 2022 Marko Linke

ETF vs Individual Stock Portfolio is something every retail investor should consider. Investing is a process that requires constant monitoring of market conditions. Additionally, it is essential to maintain an ongoing analysis of stock price movements to determine the most suitable time to buy and sell shares of a company or other security.

While an individual investor might have a finite amount of time to devote to their stock portfolio, an ETF can track changes in more than just one stock at any given time. Moreover, these funds can be purchased and held by both individual investors and money managers looking to gain exposure to the stocks of companies without buying the stocks themselves.

What are ETFs?

ETF is an acronym for exchange-traded fund and is a collection of securities that track a particular index or market segment. Many ETFs are also linked to a specific asset class, such as small-cap value. These funds can be purchased and sold like stocks on the exchange, but they usually have lower trading fees and less liquid markets than individual stocks.

Pros of ETFs

Diversification – By their very nature, ETFs hold dozens, sometimes hundreds of individual stocks providing instant diversification. ETFs may be purchased directly by investors but can also be bought and held by money managers looking to get a diversified collection of stocks without owning them individually.

Low Volatility – ETFs are traditionally less volatile than traditional stocks. This characteristic makes them a good choice for investors who want to keep their portfolios balanced and diversified without the emotional roller coaster associated with owning individual stocks.

Reduced Fees – ETFs are passively managed. This means individual stocks are selected using predetermined criteria not tied to market performance. Since ETFs are not actively managed, the result is lower management fees than their actively managed counterparts, mutual funds.

Cons of ETFs

Lack of Ownership – ETFs are not owned by the investor but rather by a fund manager or other entity. This means the investor does not retain any voting rights in the companies held. Additionally, although dividends must be paid to investors, the investor does not have the choice of how dividends are paid out, either in cash or by purchasing more ETF shares instead of stocks paying dividends.

Less Liquidity – ETFs tend to have less liquidity than individual stocks, making them harder to sell in emergencies. There are exceptions to this when considering ETFs such as SPY or VOO (1).

Liquidity Risk – When a fund manager holds an ETF, there is always a risk they may liquidate the investment before the investors can sell their stakes. For example, in July of 2022, ARK Invest decided to liquate their transparency-themed fund (2), forcing investors to wait for their money to arrive in cash instead of selling their position.

Pros of an Individual Stock Portfolio

It Can Perform Better – An ETF can contact dozens, sometimes hundreds of different stocks which are unchanged over time. Whereas, an individual stock portfolio (especially when coupled with a portfolio tracker) can be built by selecting the most compelling opportunities, while shedding any underperforming positions.

It’s Flexible – An individual stock portfolio is flexible as it can be invested in various stocks with different risk and return profiles. Investors can choose stocks to buy or sell according to their risk appetite and their individual preference, as opposed a set of pre-defined investments inside an ETF.

It’s Diversified – An individual stock portfolio can easily be diversified by including various stocks. In addition, with many brokerage accounts providing low or no-cost trades, it is easier than ever to build a portfolio that spreads risk across multiple asset classes.

Cons of an Individual Stock Portfolio

It’s Risky – An individual stock portfolio can be risky as the investor makes all the decisions. Therefore, deep research into each investment is crucial for long-term success and constant monitoring.

Higher Volatility – An individual stock portfolio, especially those lacking diversification, can experience higher volatility than an ETF. While the market experiences fluctuations, individual stock price moves can be exponentially greater than the overall market.

More Difficult to Diversify – Although an investor doesn’t need dozens of stocks to have a diversified portfolio, many experts believe (3) that between 10 to 25 stocks are necessary to be considered diversified. It can be difficult enough to research just a handful of stocks thoroughly. Two dozen positions can be overwhelming.

How to Choose What’s Right for You?

Investors have many choices in terms of investment vehicles. Your choice will depend on your personal risk tolerance, time horizon, goals, and appetite for volatility. Portfolio management takes time and involves a complex blend of discipline, strategy, and research. Stock recommendation services, such as Seeking Alpha and Motley Fool, can assist in helping select investments. But ultimately, your success will be underpinned by understanding your own strengths and limitations when investing.