Why I Use ETFs Instead of Individual Stocks

Old telephone in Gaudi museum.

Approximately 80% of all investors use individual stocks to populate their portfolios.  So why buck the majority trend and use index ETFs?  That is a reasonable question that merits an answer.  In fact, several answers.  Confession:  I do select a few individual stocks for certain portfolios, but it is rather rare.

• Investors inclined toward picking individual stocks should check out how professional mutual fund money managers perform with respect to non-managed index funds or index ETFs as recommended on this blog.  To locate some of the best research, read Richard Ferri’s book, The Power of Passive Investing: More Wealth With Less Work. 
• Look up William F. Sharpe’s article, The Arithmetic of Active Management.
• These two sources, plus many more, provide a probability argument against the advisability of stock picking.  It is a losers game.   One of the best investors of our time is Warren Buffett and I hold shares of BRK.B just to see how well his stock performs.
• By using index ETFs one will never do much better than the broad market.  Neither will one do much worse so there is a built-in risk reducer.
• Diversification:  It is much easier to set up a global portfolio if one uses ETFs.  Most investors do not have a clue how to pick stocks in the world of emerging markets.  It is a piece of cake if one uses VWO, our emerging market ETF of choice.  The same argument holds true for commodities, international bonds, precious metals, and international REITs.
• Cluster Analysis or paring low correlated ETFs with each other for further diversification is not difficult if one uses ETFs.
• The next Google is buried somewhere within an ETF.  Also buried in an ETF is the next failure.
• If you are an experienced stock picker, follow these instructions.
  • Determine the asset classification for each stock in your portfolio.
  • Run a comparison between the stock and the appropriate ETF using the capability found at Yahoo! Finance.  Which is the better performer?
• If you have a stock heavy portfolio, track the performance using the TLH Spreadsheet.

The law of averages states there will be stock picking investors who will outperform the broad market.  If you fall into this favored company, keep doing what you are doing.  For most mortals, index investing is a much safer bet.