Why Stocks are Better Than ETFs

Have I Lost My Mind?

It is clearly better for many investors to invest in an ETF or low-cost mutual fund than to pick individual stocks. However, there are some very powerful reasons why you might want to consider doing both. There are some specific advantages to owning stocks over ETFs. In this post I want to share ten of the reasons why I keep investing in individual stocks rather than just dividend growth ETFs.

Handpick the Cherries

When you buy a fund, you are getting diversification. That is good. But that is also not so good. The fund manager is probably following an index. The index defines the mix of investments. Invariably you will get some bad cherries. I believe it is possible to carefully pick the best stocks and not have an ETF with a mix of good investments and also some less desirable holdings.

The Dividends Arrive Sooner

Reason Number Two: You will receive your dividends sooner so that you can use them sooner. Funds collect the dividends when they are paid and hold onto them until they decide when to pay you. So they can put your dividends into a holding pattern and this gives them an opportunity to get interest on the cash while you wait. If, for example, they pay dividends at the end of March, June, September, and December, then there are dividends that are being paid each of the months of each quarter, and even during those months, that are not showing up in your account until the fund decides it is time to pay them.

You Can Reinvest the Dividends Faster

As soon as my dividends are posted, I can buy more of any investment, or I can buy a CD. For example, It is not uncommon for us to receive anywhere from $8,000 to $10,000 per month in dividends. At present 1-month CD rates, I can start earning 4% on that cash. Bear in mind that some ETFs and mutual funds receive monthly dividends from holdings like Realty Income (Ticker: O), but they only distribute them quarterly. For example, Vanguard’s ETF VNQ holds shares of O, but VNQ doesn’t pay the O dividend to the ETF investors every month. VNQ (Vanguard Real Estate ETF) has Realty Income Corp in its top ten investments. Do you want to wait for the dividend?

Zero Expenses

Even though many ETFs and some mutual funds have reasonable expense ratios, the best expense ratio is 0.0%. When you buy stocks, you can own them for decades and never pay a nickel. You get to keep every penny. So that makes me a penny pincher.

Higher Dividend Yield is Possible

With a fund you are getting an average of many different yields for the holdings in the ETF or mutual fund. You are probably not getting the best yield that you might get by being more focused on buying higher yield investments. For example, while VYM has a decent yield of 2.96%, the average yield on our current portfolio value is 5.14%. This can be achieved by adding in investments like BDCs and REITs.

Options Trading is Easier and More Ubiquitous

While you can trade options on a few ETFs, for the most part the field is limited. With many stocks, like Ford, Tesla, Pfizer, Walmart, Target, Home Depot, Abbvie, and Valero, the opportunity for trading covered calls and cash covered puts is far greater.

Profits Can Easily Be Gained

You can sell a stock if you feel it has inflated in value. That is hard to judge with an ETF. With an ETF, the quick rise of an individual stock is entirely under the control and discretion of the fund manager. With individual stocks, you can choose the ratio of the investment to the total investments you hold.

Dividend Growth Can Be Accelerated

When I buy an individual stock, I can choose those that have a history of dividend increases that are greater than 5%. The dividend growth isn’t watered down by the less desirable dividend growth stocks in a fund like VYM. ABBV, for example, has a 5 Year Growth Rate of 16.92%. ABBV is one of the top ten investments in VYM, but the other top ten don’t necessarily have that same high dividend growth.

Taxes in Taxable Accounts

While this doesn’t matter in an IRA or ROTH IRA, “it is easier to manage the taxes on your individual stocks. You are in charge of when you sell, so you control the timing of taking your gains or losses. When you invest in a mutual fund, the fund determines when to take the gains or losses and you are assigned your portion of gains. This is true even if you just bought into the fund at the end of the year.” – Investopedia

Diversification Can Be Controlled

You might own more than five percent of some investments. For example, ETF SPY (SPDR S&P 500 Trust ETF) has 6.67% invested in Apple (AAPL) and 5.63% invested in Microsoft (MSFT). That is a very heavy weighting when you consider the top ten SPY investments make up 25.47% of the ETF. In other words, 12.3% of the fund, almost half of the top ten, are focused on AAPL and MSFT.

With a mutual fund like NASDX (Shelton Capital Management Nasdaq-100 Index Fund), Microsoft is 12.52% of the fund and Apple is 11.70%. That means almost 25% of the fund’s assets are focused on two companies. If you own more than one ETF or mutual fund, remember the overlap and exposure might increase.

Summary

I am not suggesting that every investor should invest in individual stocks. However, I hope you can see that there are benefits to having a mix of both ETFs and some good dividend growth stocks.