I am the author of the book, 'Building Wealth Made Simple.' My journey in personal finance began when my Father showed Dave Ramsey's books.
Which Investing Strategy is Best?
The question, "Which investment strategy is best?" Can be answered in a multitude of ways. I previously argued that investing in Exchange Traded Funds is generally a better investing strategy than stock picking. I did, however, say "generally."
Despite my position on the superiority of ETF investing, there are times where stock picking may make sense for an investor. In this article, I will highlight some of these scenarios.
What constitutes as the best investment strategy depends on individual goals. For example, though many investors talk about "beating the market," that is not always the primary goal for an investor. For example, I invest in bond ETFs and dividend ETFs. It is unlikely I will beat the market with that kind of strategy, but beating the market isn't my goal because capital appreciation is a secondary goal for me. I prefer income-based investing. Thus, the question "Which investment strategy is best?" isn't as simple to answer as it may seem. Rather, the answer to the question is based on an investor's goals.
Better Tax Efficiency
Exchange traded funds, index funds, and mutual funds have something that is called a 'turnover rate.' None of this matters in a tax deferred or tax free account, but in a taxable account it makes a difference. If your funds sell a stock at a profit, that profit gets taxed.
With stocks, however, when you buy a stock, you hold that stock until you sell it (unless the stock gets liquidated due to a buyout or bankruptcy). Thus, you are only taxed on capital gains (the stock going up in value) when you sell the stock or if it gets liquidated. This results in a lower tax bill than with ETFs that are taxed when they sell stocks at a profit. If you invest in growth stocks that do not pay any dividends, you will not be taxed unless you sell the stock or it is liquidated at a profit. Thus, stocks are more tax efficient than ETFs. This can mean a lower tax bill. For most people, the difference will be negligible, but if you are in a high income bracket or if you have a lot of money invested in a taxable account, this advantage becomes more significant.
A commonly cited reason that people give for stock picking is the ability to control their investments. If you invest in a fund, you have limited control of the fund because you cannot control what a fund does beyond its investment parameters. If you invest in individual stocks, however, you can control what stocks you are invested in and how much of your capital is put into each stock.
Probably around 1% or less of stock investors beat the market over a five-year period, but not everyone picks stocks to beat the market. For some people, however, beating the market would be nice, but they have no expectation of beating the market. Instead, they are investing for income from dividends rather than capital gains. Some people may have a minimum dividend yield threshold and they want to pick their own stocks because of this. For example, some dividend investors do not want less than a 3% yield for any stock they buy.
Some people are socially conscious investors. This means that part of their stock selection process is based on their ethics. For example, a vegan investor may be against killing or using animals for food so they do not invest in any companies that sell meat or dairy products. There may be some ETFs that will accommodate those beliefs, but the investor may have some additional goals in mind. Thus, ethics could also be a reason why an investor may forego funds and pick stocks instead.
They Believe They Can Beat The Market
There are some investors that are confident they can outperform the market. As unlikely as this prospect is, there are some fund managers that have outperformed the market on a regular basis, and there are also regular, every day citizens who have reported being able to beat the market as well.
I suspect that many people's claims about beating the market are dubious, but there are some who have a track record of doing so. For example, for most of his years in the market, Warren Buffett has been able to beat the S & P 500 index. Lately, he has not beat it; however, he attribute this to having too much money and having to spread out his investments to companies that are less ideal than what he would have normally preferred to pick. When you have as much money as Warren Buffett does, you have to take some things into consideration that most investors do not have to worry about. For example, Warren Buffett does not want to buy so much stock that he ends up becoming a larger share holder in a company than he wants to be. For example, he one time accidentally became a more than 10% shareholder of Delta Airlines.1
There are, however, some private investors that have YouTube channels that have not only claimed to have beaten the market, but they have put their numbers out. For example, Jeremy from the YouTube channel Financial Education seems to make a lot of good calls on his investments, and he has been transparent with his numbers and it appears that he does regularly beat the market. A lot of YouTube channels about personal finance and making money have owners that inflate their credentials, but Jeremy seems to be the real deal.
Stock Picking Is Their Hobby
Some people have funds in their investment accounts, but they also like to "play the market." These people may have disposable cash and they enjoy researching companies, picking stocks, and talking about "the one that got away."
Stock picking may seem like a weird hobby, but for people who like to crunch numbers and people who are visionaries may enjoy picking stocks. This allows them to do something tangible with their hobbies, and really, being a stock investor that knows a lot about the companies they are invested in is a quick way to become the cool person at the table.
In the end, there is no objective answer to the question, "Which investment strategy is best?" While I do believe that funds such as ETFs are typically a superior investment strategy in comparison to stock picking, there are still valid reasons for deciding to pick stocks instead.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.