When I started my series for new dividend investor beginners 2 weeks ago, I noticed that many people disagreed with ETF dividend investing. In fact, there were a lot of readers who claimed that investing in 1, 2 or 3 stocks (for $333 each including commission fees) with $1,000 would be better off than investing in a dividend ETF.
I had second thoughts on both investing strategies and wanted to look at the pros and cons of each of them. I actually think that to be fair, we must talk about beginner investors vs experienced investors.
First, I wanted to explore the fee aspect when you are starting your dividend portfolio and here are my conclusions:
Fees and yield for ETF and Stock Picking
If you want to invest $100 per month in any stock you would have to wait each 3 months to buy new shares and pay about $5 per transaction (in order to reduce the transaction fees). At the end of the year, you will have paid $20 to get $1180 worth of shares (your initial $1,200 minus commission fees). This corresponds to a 1.69% transaction fees compared to the 0.40-0.60% range for ETFs.
The other aspect to consider is that you will not miss any dividend distribution with ETFs while you have to wait 3 months between each purchase with the stock picking option. Therefore, you will miss out on dividend income for your portfolio.
The last aspect regarding fees and yield would be rebalancing your portfolio. With a small amount invested, you are stuck with your stocks ;-). If you start rebalancing your investments, you will pay too much in transaction costs when compared to the size of your portfolio.
Then, I have a second question that comes to mind:
What is the difference between a beginner and an experienced investor?
Back in 2003, I started my stock trading adventure. I had just finished my bachelor degree and thought that taking $19,500 from my line of credit to invest in the stock market was a good move. It was way more than a good move since I bought my house with $50,000 cash down in 2006 and most of my money came from my trading activities. Back then, the oil income trusts helped me generate high dividend yields along with huge capital gains. So I can understand why some readers claim that stock picking is the best way to invest (especially if you only stick with aristocrats).
However, beginner investors usually lack in 3 major aspects when compared to experienced investors:
#1 A lack of knowledge (how to analyse a stock, read financial statements, make projections for the company’s future)
#2 A lack of emotion management (they don’t know how they will react when their stocks will plummet).
#3 A lack of money (considering that most beginner investors will start with a small lump sum amount and invest monthly afterwards.
This is why I think that trading ETFs is a better option for beginner investors. If you go back before the crash, the ETFs might show a lesser yield than somebody who picked JNJ and MMM but also show better returns than someone who picked GE and PFE. Those 4 stocks were aristocrats back in 2007 and a beginner investor would probably not make the difference between the 4 of them. By choosing an ETF, he avoids this dilemma and starts his learning experience in the world of investing.
A beginner investor could have made little to no difference between JNJ and GE and would “gamble” his investment in one of them. However, if you pick the wrong stock, you may have a very negative surprise.
Final Thoughts on ETFs vs Stock Picking
While the ETF strategy sounds appealing for young investors, its approach generates a lot of fees (MERs of about 0.40 to 0.60%) when your portfolio become sizeable. At $5,000 to $10,000, you are probably better off switching to dividend stock picking to avoid too much in fees.
The other down side about ETFs is that they will also include dividend stocks that underperform and therefore, affect the overall yield of your portfolio. Then again, as you learn the investing ropes, switching to a dividend stock portfolio may be an interesting option.
As an experienced investor, you can easily build a strong dividend paying portfolio with a few stocks and save most of the fees with a buy and hold strategy. Since accumulating stocks cost about the same, there is definitely an interest for stock picking.
What’s your take? ETFs or Stock Picking?