Why You Should Probably Put Your Money In An ETF and Chill
And the one base case where investing in individual stocks makes more sense.
Why Investors Fail To Beat The S&P 500
It’s no secret that most investors underperform the market over the long-term. You’ve probably seen charts like the one below somewhere in your online data feed.
I don’t know how accurate the chart above actually is, because I wasn’t able to find the study it was based on. But I have read countless other studies, primarily the DALBAR Quantitative Analysis report, which tracks how average investors measure up against the market. You can check out a snapshot of their latest report here. DALBAR tracks Fund investors and continues to find that even those who opt for a more passive investment approach with Index Funds and ETFs tend to consistently underperform the S&P 500.
The primary reason the average investor underperforms the market is lack of patience. People are emotional creatures, and we tend to make impulse decisions based on how we feel. That’s why you see investors chasing returns and panic selling, the two best ways guarantee below-average performance.
Opting to invest in individual stocks over ETFs exponentially increases the level of emotional decision-making.
Therefore, it’s no surprise that, for the average investor, the best results come from investing in a portfolio of Funds, setting it on autopilot, and not frequently checking the market or your portfolio.
The Pros Don’t Do Much Better
If the average investor underperforms the market over the long-term, you might expect professional investors to have a much better track record. However, that assumption would be incorrect. Between 2001 and 2023, roughly 64% of actively managed large-cap U.S. equity funds underperformed the S&P 500. In fact, actively managed funds only managed to beat the S&P in three of those 23 years; 2005, 2007 and 2009. Some of the worst years of underperformance were 2011, 2014 and 2021, when over 80% of actively managed funds trailed the S&P 500.
Keep in mind that these professionals that likely studied finance in college, have worked in the field for years, and spend their entire day focused on delivering alpha to their investors. If more than half of professionals fail to consistently outperform the S&P 500, what makes you think you’ll do any better?
I’m not saying that you can’t, but statistically, the average investor is unlikely to accomplish this feat.
Just Index (or ETF) and Chill
In my opinion, 95% of investors should create a simple portfolio made up of Index Funds and ETFs, put in on autopilot, and enjoy life. On average, the S&P 500 returns about 10% per year. Of course, we seldom see “average” years, returns are more likely to be +20% or negative, but history shows that the longer we stay invested, the higher the probability of achieving that 10% average market return. Here’s a good strategy to follow.
Design a Simple Portfolio
Put your investment strategy on autopilot
A longer investment horizon is better
Ignore stock market news and sleep well at night
Enjoy your wealth in 30 years
A case for investing in Individual Stocks
Since I explicitly write about individual stocks, I don’t want to completely undercut myself with this post. Here’s my reasoning for investing in individual stocks.
The main reason to invest in individual stocks over a way more passive Index or ETF portfolio is control and customization. There are countless Index Funds and ETFs available to the average investor, but there likely isn’t a perfect fund that aligns with your investment goals.
So, if your goal cannot be accomplished with Index Funds or ETFs, the next best option is to build a custom portfolio. Let me give you a personal example.
My goal is to build a growing dividend stream by investing in high-quality companies with a focus on total return. While I like many dividend ETFs, none of them perfectly match my investment strategy. SCHD, DGRW and DGRO are probably the closest, but I don’t want to settle for “close enough”. Additionally, I also enjoy the research aspect of active investing, so designing my own portfolio doesn’t feel like grueling work.
For me, it makes sense to build a custom dividend growth portfolio. However, I accept that I may underperform the market, especially in the short-term.
The upside is that I like every company I own, I understand what they do, and I know how well they’ve performed historically. I bought them at attractive prices, and I intend to hold them for as long as my opinion doesn’t change. With an ETF, I would be forced to own companies I don’t particularly like or see value in. So, for me, control and customization is very important. And if I end up underperforming the market in exchange for that control, so be it.
If your ideal investment strategy can’t be easily executed with a mix of Index Funds or ETFs, investing in individual stocks may make sense for you as well.
Be Careful How You Use Information
In a perfect world, someone would simply tell you to buy X, Y and Z stock at a certain time and price, and your portfolio would beat the market and make you rich. The problem is that nobody truly knows what will happen with any stock tomorrow, next week and much less a year from now. This’s why it’s so important not to blindly follow someone else’s opinions.
Take me, for example. In this newsletter, I share opinions on various stocks, often concluding that a given stock may be a lucrative investment opportunity. And that may very well be the case—but just because it works for me doesn’t mean it makes sense for you to invest in the same stock at the same time.
Warren Buffett has a great analogy that fits well here.
Think of this newsletter as a game of baseball, I’m the pitcher and you’re the batter. I’ll pitch (investment ideas) to you, but you get to decide which ones to swing at (consider). The beauty of this game is that you’re under no obligation to swing. There’s no 3 strikes and you get unsubscribed. You can let 100 investment ideas go by before one finally piques your interest.
Not every investment opportunity I write about will be profitable, so it’s in your best interest to form your own opinions rather than blindly consider everything I throw your way. And this should really be the approach you take with all investment content online.
If your ideal investing strategy aligns with mine, I believe you’ll find many of my ideas interesting. If your strategy differs, you may still find value in some of my research and, occasionally, a stock idea that fits your own approach.
I really enjoyed your Living off VIG video. Have you or can you please do the same for SCHD?
Thanks Quality At A Fair Price