 Personal Finance Power Point Presentation, Stock vs. ETF, prepare to get financially fit by practicing personal finance. Most of this information comes from Investopedia Stock vs. ETF, which should you buy, which you could find online. Take a look at the references, resources, continue your research from there. This is by Brian Beers, updated January 12, 2022. In prior presentations, we've looked at investment goals, investment strategies, investment tools, keeping the two primary categories of investment in mind. That being fixed income, typically bonds, and then the equity, typically stocks. We're focusing here on the equity or stock side of things as we ask the question of stock vs. ETF, which should you buy? Perhaps you've decided that you want to invest in a particular sector. So now we're thinking stocks, we're breaking it down to the sector that we want to be investing in. How would we be breaking that down? You might be asking, well, you're looking at your time horizon. How long do you want to be investing? What's my risk tolerance level? And then you're trying to basically line up your investments to or to fit with that strategy. So now you may be in the position of choosing between buying stocks or an exchange traded fund. That's going to be an ETF. You also might have mutual funds in the mix here that you're taking a look at. So remember that we've got the stocks, which represent ownership in a corporation. And so typically corporations are formed in a corporation. They're going to make the stocks, which are going to be standard units of basically ownership. And then that corporation might be on an exchange, which is where we would typically be purchasing the corporation. They're on the exchange in order to help generate capital for them, which is good for the investors because they're more likely to be able to purchase the stocks. And then you could have these instruments, such as ETFs, such as mutual funds, which could be tools to help oftentimes smaller investors get more diversification as opposed to buying individual stocks. So that's where the question starts to come in here. So making this choice is no different from any other investments decision. As always, you want to look for the ways to reduce your risk. And of course you want to generate a return that beats the market. Reducing the volatility of an investment is the general method of mitigating risk. So volatility, kind of risk that's going to be involved, the fluctuation mitigating the risk. So most investors give up some upside potential to prevent a potential catastrophic loss. In other words, the major kind of mitigation of risk that we have is diversification. Diversification is a double-edged sword because if we were to say, well, stocks are more likely to do better, say, than bonds, for example, then we might say, well, why wouldn't I put 100% of my money into the stocks, which have more potential for the upside? The reason is because if the downside happens, you have a lot more exposure to that potential downside. So most people then say, I want to hedge or mitigate that risk. So what I'm going to do is I'm going to diversify between stocks and bonds. We can say that same strategy would hold in, say, just stocks in general. If I have all my money in one company, even if that company is quite secure, quite solid, if it's in like Apple or something like that, it's still in one bucket. So you might say, well, Apple has poor earning potential than other stocks. So why would I invest in other stocks or other sectors? Why wouldn't I just invest in this stock here? And the reason would be, well, if there's a problem in that one particular area, you're going to have a problem. Therefore, you're going to diversify. So you're going to mitigate or lower possible earning potential in order to safeguard and hedge on the downside. So an investment that offers diversification across an industry group should reduce the portfolio's volatility. This is one way that diversification through ETFs works in your favor. So we've got the achieving alpha. Alpha is the ability of an investment to outperform its benchmark. So if you're looking at and trying to think about how good is your investment doing, you can look at the returns, you can try to benchmark it or compare it to a benchmark. So anytime you can fashion a more stable alpha, you will be able to experience a higher return on your investment. There is a general belief that you must own stocks rather than an ETF to beat the market. In addition, many investors are under the impression that if you buy an ETF, you are stuck with receiving the average return in the sector. So if you talk to very aggressive, more aggressive type of traders, they're going to be saying, hey, look, I'm going to invest in stocks because I think that you're going to be able to choose your own stocks more easily and so on and so forth and possibly be able to put together a portfolio that's going to be beating the market. If you're just choosing an ETF or possibly like a mutual fund or something like that, then you're just settling for the average return in the market as opposed to really going after the higher returns that possibly they think they can get through here. But again, you really don't know anyone's actual record until you look at their performance over their lifetime. So remember anytime someone says that to you, if the market is going up in the short term, everybody's a genius. They might be outperforming the market, but everybody's going to be doing good at that time. Really, how did they fare? Were they able to weather out the dips in the market? Because they are inevitable over the long term. So neither of the assumptions is necessarily true because it depends on the characteristics of the sector. Being in the right sector can lead to achieving alpha as well. So when stock picking might work, industries or situations where there is a wide dispersion of returns or instances in which ratios and other forms of fundamental analysis could be used to spot mispricing offer stock pickers an opportunity to exceed expected returns. So in other words, if you're picking individual stocks and you're really good at basically breaking down the financials and looking at the ratio doing a ratio analysis of the financials and being able to compare that to the valuation represented in the price, that's the kind of thing in an environment where that kind of thing is useful. That's when the stock pickers that are good stock pickers might be able to pick up more value and beat the returns and the long run picking corporations that have value based on their analysis greater than what's being represented in the stock market. So based on your research and experience, maybe you have a good insight into how well a company is performing. This insight gives you an advantage that you can use to lower your risk and achieve a better return. So in that case, if you were say to invest in say one sector of one area and you're saying instead of investing in like the whole sector then what I'm going to do is look at the individual stocks in that sector and determine the ones that I think have the best valuation compared to the price. If you could do that well, then maybe you can instead of just picking an average index fund of the sector, you might be able to be picking more valuable stocks. Again, that's hard to do and you got to have good analysis tools to be able to do that as opposed to saying I'm just going to pick say like an index fund that represents the average of the sector for example. So good research can create value added investment opportunities rewarding the stock investor. So the retail industry lends itself to stock picking. The retail industry is one group in which stock picking might offer better opportunities than buying an ETF that covers the sector. Companies in the sector tend to have a wide desperation of returns based on the particular products they carry. This may create an opportunity for the insightful stock picker to do well. So for example, let's say that you recently noticed that your daughter and her friends prefer a particular retailer. Upon further research, you find the company has upgraded its stores and hired new product management staff. This led to the recent rollout of new products that have caught the eye of your daughter's age group. So far the market has not noticed. So you're basically trying to say based on my daughter's information here, I've got some inside information and this kind of thing, again, it's this kind of thing is a little bit more outside what you might do in the normal ratio analysis. Because oftentimes when you're looking at the financial statements, you're looking at the right ratio analysis to see if there's some kind of value that's not being properly represented in the stock price. Or you can you can try to take a look at a trend kind of approach and you're looking at things and saying, wow, the trend and these companies, it doesn't seem to be in alignment with the trend that I'm seeing, you know, that's happening in the real world. There's market opportunity that no one's picking up just because they're not going in the right direction. The companies think they're driving the market when possibly you're seeing the market has a desire that's not being met by the current companies. So this type of perspective and research might give you an edge in picking the stock over buying a retail ETF. So if you're doing that, you're saying, hey, look, I think there's a huge market for this particular type of clothing. I think it's kind of in the entertainment area these days, too. You're looking at the standard Netflix and you're looking at you're looking at Disney and Amazon. You're like, man, a lot of the stuff that they're making all seems kind of homogenous and it's kind of doing the same type of thing. It seems like they're alienating a big market that so you might then say, well, maybe I won't invest in the sector there because maybe you'll invest in the particular companies that are certain just starting to pick up on the market that you feel like is being not catered to and could have earning potential and possibly you can make out in that way. So company insight through a legal or sociological perspective may provide investment opportunities that are not immediately captured in market prices. So when such an environment is determined for a particular sector and where there is much return dispersion, single stock investments can provide a higher return than a diversified approach. So a general approach would be I'm just going to invest in retail overall or I'm just going to invest in basically the entertainment sector basically overall, which would give you maybe an index of the sector. And you're saying, no, I think I think I'm going to invest in a particular area because I see value that's not being picked up that I think can add a lot to the profits. So when an exchange trade fund and ETF might be the best choice. Now we're looking at the ETF. You could maybe think of a similar approach with like a mutual fund. For example, sectors that have a narrow dispersion of returns from the mean did not offer stock pickers and advantage when trying to generate market beating returns. The performance of all companies and these sectors tend to be similar. So now you're looking at the sector and you're saying they don't have any really competitive advantage. For example, do you look at the ratios and they're all basically trying to beat on maybe not on differentiation, but just on better service. And so they all look pretty much the same. Well, in that case, you may not be able to beat anything out by looking at analyzing each individual financials or by having some particular insight that they're not that you could have particular companies in through diversification or through a company picking up a different angle, for example. And therefore you might just want to invest in the index in the average so that you get a diversified portfolio of those particular stock sectors. So for these sectors, the overall performance is fairly similar to the performance of any one stock. The utilities and consumer staples industries fall into this category. In this case, investors need to decide how much of their portfolio to allocate to the sector. Overall, rather than pick specific stocks. Since the dispersion of returns from utilities and consumer staples tend to be narrow, picking a stock does not offer a sufficiently higher return for the risk that is inherent in owning individual securities. Since ETFs pass through the dividends that are paid by the stocks in the sector, investors receive that benefit as well. So consider ETFs when performance drivers are unclear. Often the stock in a particular sector are subject to disperse returns. However, investors are unable to select those securities which are likely to continue outperforming. So in other words, if you're looking at it and you're saying, I don't know which which companies are going to outperform or why you're looking at a sector and saying, you know, some companies might be doing better than others, but the reasons are rational as to why it is. It doesn't look like it's in the fundamentals. It doesn't look like they have a better valuation perspective from the ratios. I don't see the angle that I think that is differentiating them from others. So so then you might just have to bet on the sector as a whole because you don't you can't pick the winners or losers. You don't have a rationale to decide which ones to be investing in in particular. And therefore just that bet and the sector as a general one of them will win. We don't know which one I want to be invested in the sector to pick up the gains because I think some I think the sector in and of itself will do well. I just don't know which company will do well in the sector. So therefore they cannot find a way to lower risk and enhance their potential returns by picking one or more stocks in the sector. So if the drivers of the performance of the company are more difficult to understand, you might consider the ETF taking like an average of the sector. So these companies may process complicated technology or processes that cause them to underperform or do well. Perhaps performance depends on the successful development and sale of new unproven technology. The dispersion of returns is wide and the odds of finding the winner can be quite low. So if you're looking at something like new technology like there's a gaming thing or like you're looking at the coin base cryptocurrency kind of world and stuff like that. You're saying, hey, look, I think I know there's value here. I know that something's going to break out in this area. But I know who's to say who's going to win. I know that this thing might be a monopoly network kind of thing kind of like a Facebook. Someone's going to be the ultimate winner of this particular sector because it's a monopoly type of a natural monopoly industry. But I don't know who the winner is going to be. So then you might bet on the sector as a whole instead of the individual stock industries where ETFs are a better option. The biotech industry is a good example as many of these companies depend on the successful development and sale of new drug. So that obviously we don't know which drugs are going to be the winners. If the development of the new drug does not meet expectations in the series of trials or the Food and Drug Administration, the FDA does not approve the drug application. The company faces a bleak future. On the other hand, if the FTC approves of the drug, investors in the company can be highly rewarded. So we can just look at Anthony Fauci's portfolio investments and probably get a good. Any case, certain commodities and specialty technology groups such as semi-contactors fit the category where ETFs may be the preferred alternative. For example, if you believe that now is a good time to invest in the mining sector, you may want to gain specific industry exposure. However, let's say you are concerned that some stock might encounter political problems that could hinder their production. So clearly when you're looking at the sectors in general and you're trying to think, okay, we've got this global warming thing. We've got regulations that are happening. What's that, you know, what's going to be the impact on the overall sectors with relation to those. So in this case, it is wise to buy into the sector rather than a specific stock since it reduces your risk. You can still benefit from growing in the overall sector, especially if it outperforms the overall market. So what's the bottom line? When deciding whether to pick stocks or select an ETF, look at the risk and the potential return that can be achieved. Stock picking offers an advantage over ETFs when there is a wide dispersion of returns from the mean, meaning you've got companies in a sector and those companies are making different returns, meaning there's probably differentiation within the companies. They're not all just competing on price and therefore you might be able to pick which ones you think are going to be the beneficial stocks, either through who's being more efficient in their revenue generation using the ratio analysis tools or by looking at the sectors who you think are more aligned with the market that they're touching on the market base that you think has earning potential. And with stock picking, you have the ability to gain an advantage using your knowledge of the industry or the stock. ETFs offer advantages over stocks in two situations. First, when the return from the stock in the sector has a narrow dispersion around the mean and ETF might be the best choice. So now you've got a bunch of stocks that are, you know, looking somewhat similar in nature. You don't know, so you might invest in just the average so you can diversify it across the board on them. Second, if you are unable to gain an advantage through knowledge of the company and ETF is your best choice. So you might be saying, yeah, this stuff is out. I see the potential here. I think it's worth my investment, but I don't know which one has the competitive advantage. I don't know who the winner is going to be. Even if it's a monopoly type of industry, someone's going to win. I'm betting in the sector because I don't know who's going to be the winner. But I think the sector of itself will win and will grow. So whether you are picking stocks or an ETF, you need to stay up to date on the sector or the stock in order to understand the underlying investment fundamentals. You do not want to see all of your good work go to waste as time passes while it's important to do your research so you can be able to choose a stock or ETF. It's also important to research and select the broker that best suits you.