With the increased popularity of index funds and ETF’s, does it still make sense to invest in individual stocks?
Funds have certainly made it easier to invest in the stock market. For instance, they are a great way to systematically invest 401K contributions with each paycheck. But many professional investment advisors still prefer building portfolios by carefully selecting individual stocks.
Here are a few reasons why!
Custom Tailored Portfolios
Investors can tailor their portfolio to their personal risk tolerance, investment goals and emotional comfort levels, more so with a combination of individual stocks and other investment types rather than solely with funds.
Diversification
Academic studies[1] have demonstrated that investing in 20-25 individual companies can provide adequate diversification, when all economic sectors are represented correctly.
Potentially Higher Returns
Actively managing a carefully selected stock portfolio has the potential to generate better returns than the broad stock market, especially during a market downturn. Better yet, a portfolio containing only the highest quality companies may provide better returns with less risk.
Greater Control
Complete control over stock selection, position size, and timing of investment decisions allows for a more personalized investment strategy. For instance, they can choose to favor or avoid certain investment factors such as growth, value, income, small, large, or U.S vs. international holdings.
Income
If growing income streams are a part of your investment goals, you may benefit from investing in select stocks that pay above-average dividends and have a history of raising them each year. On the other hand, if you are in the wealth-building stage of life, you can automatically reinvest dividends to compound your investment returns.
Tax Efficiency
With individual stock ownership you control the timing and realization of capital gains and losses. Tax loss harvesting strategies are an important way for investors to reduce their tax income bill.
Inflation Protection
Inflation is a saver’s worst enemy, and combating it is crucial. One of the best defenses against inflation is to own businesses. You can read our article, A Golden Way to Protect Yourself from Inflation for more on this important strategy.
Takeaway
There could be a place for both index funds and individual stocks in your investment portfolio. In fact, many professional advisors prefer the more customizable strategy of building high quality, diversified stock portfolios with individual companies. While at Pring Turner, we continue to use a highly personalized combination of the two in managing our client’s hard-earned wealth.
[1] Source: A Random Walk Down Wall Street – Burton Malkiel