Blue Line Investing, Article 10 of 12
Individual stocks, stock mutual funds, stock exchange-traded funds (ETFs) – which one(s) are right for you? While we can not answer that question, we would like to share why we prefer using ETFs as our primary investment choice. In addition to how well ETFs conform to our Blue Line Investing process, additional benefits include diversification, marketability, and selectivity.
From a diversification standpoint we prefer ETF’s over individual stocks. To be clear, this doesn’t mean we don’t or won’t invest in individual stocks. It simply means we prefer to minimize the risk associated with investing in individual stocks. ETFs help us accomplish that by allowing us to invest in a diversified sector rather than invest in a few individual companies. For instance, share prices of medical device company Zimmer Biomet Holdings, Inc. (symbol ZBH) recently dropped over -20% in the past two weeks. In comparison, shares prices of the iShares U.S. Medical Device ETF (symbol IHI) dropped over -4% over the same time period. We prefer to capture most of the upside with less of the downside rather than attempt to capture all of the upside along with all of the downside.
From a marketability standpoint, we prefer ETF’s over mutual funds. Consider for instance the Vanguard 500 Index mutual fund (Admiral Shares symbol VFIAX) compared to the Vanguard S&P 500 ETF (symbol VOO). At first glance these two investments appear the same. They both invest in the same 500 stocks that represent the S&P 500 Index, both own those 500 stocks in the same proportions, and both have the same annual underlying expenses. So in essence they are the same, right? No, they are not. The reason is their individual marketability. For instance, with all mutual funds, no matter when you place your buy or sell order during the trading day, you always receive the share price at the close. Since ETFs are marketable like individual stocks, whenever you place your buy or sell order during the trading day, you receive the price at that moment in time. Depending on the specific day of purchase and sale, and depending on the volatility of the market on those given days, you can realize a different return over the long run by investing the same amount of money in these two similar, yet different, investments.
From a selectivity standpoint, we again prefer ETF’s over mutual funds. There are occasions when it can be advantageous to avoid certain sectors of the stock market, especially when a sector is experiencing a negative primary trend. This can be one of the drawbacks to investing in indexed investments over the long run that remain fully invested in all sectors. For instance, during the summer of 2014 the energy sector topped. By the time that sector reached the bottom in early 2016 it lost over -48%. So for passive investors who invested in an index-type investment, their return was impaired for the year by the negative performance from that one sector. Is there a way to avoid this? We believe there is. One possibility would be to reconstruct the S&P 500 Index by using sector ETFs in similar proportions. Then, when any sector violates your sell discipline just simply remove it from your investment portfolio. This could help lessen the negative impact to your investment portfolio from the price decline in that sector.
Depending on your investment philosophy and process you will likely use one or a combination of these investment choices. Now that we have explained why we prefer using ETFs, in our next article we will explore some of the potential benefits of selectively incorporating inverse ETFs in your investment portfolio.
Past performance is not indicative of future results. This material is intended for educational purposes only and is not financial advice or an offer to buy or sell any product or to adopt a particular investment strategy. The investment strategy discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances. The opinions expressed are those of Blue Line Investing and are not necessarily those of Gordon Asset Management, LLC and are subject to change without notice. Blue Line Investing reserves the right to modify its current investment strategies based on changing market dynamics or client needs. Advisory services offered through Gordon Asset Management, LLC (GAM). GAM is an SEC-registered investment adviser. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (866) 216-1920. The principle office of Gordon Asset Management, LLC is located at 1007 Slater Road, Suite 200, Durham, North Carolina, 27703.