If you're just about to start on your investing journey – which is a key part on your road to financial freedom – you may be wondering whether it's best to invest in individual stocks or ETFs (Exchange-Traded Funds).
I'll be talking and comparing both here, but, with keeping 2 crucial things in mind. You'll see it once you'll see it, I promise.
What Is Investing?
I don't think I need to spend a lot of time explaining what investing is.
Any investment, ideally, is made with the hopes of getting something (more) in return.
This doesn't apply only to financial investments:
- Investing time in relationships with your loved ones hopefully increases the bond you have with them;
- Investing time in your education hopefully increases your chances at that dream job you've always wanted since you were a kid, and also increases your chances at an above-average salary;
- Investing your time into binge-watching Netflix hopefully provides a sense of escapism, wonder, and entertainment
But, since this is a blog about wealth and making money, let's put our blinders on and reign in our focus to financial investments only.
You invest your money with the hopes of it appreciating in value that you then pocket at some point in time.
Your money is able to grow through compound interest and the Rule of 72.
What Is a Stock?
A stock is an asset that is traded on financial markets, or exchanges, like a New York Stock Exchange, or a Nasdaq. Companies issue stock to raise money from investors. A company uses this money to fund its operations or to purchase other companies.
Once a company goes public (IPO), retail investors like you and me can buy shares. Most platforms also allow you to buy fractional shares of companies' stocks.
For example, at the time of writing Meta's stock price is $232.00.
This means that you can buy 1 full share of Meta at that price, 2 for $464, 3 for $696, and so on and so forth.
But, with fractional shares, you can also buy 25% of 1 share at $58. Or 10% at $23.2. This is a good thing because the barrier-to-entry on the stock market is significantly lower vs having to wait until you're able to pay 1 full share (also, the stock prices of any company change multiple times an hour).
Now, on to ETFs.
What is an ETF?
An ETF (short for Exchange-Traded Fund), is a type of index fund.
Essentially, an ETF is a basket of different stocks from different companies. And, just like stocks, ETFs are traded on exchanges.
These exchange-traded funds pool together money from investors (you and me) into shares from different companies.
So, an ETF, like the S&P 500 (ticker symbols VOO or VUSA) tracks around 500 of the largest (based on market capitalization) US companies. (like Apple, Amazon, Alphabet, Coca-Cola, Verizon, Salesforce, and … about 494 others).
Should a company in that list fall below the 501st largest US company, that company is then taken out of the index, and the company which was 501st will be included.
In that way, the list is always up-to-date.
Here's a current list of all companies in the S&P 500.
There are a lot of ETFs with different specializations:
- ICLN is an ETF that tracks the performance of global green energy companies
- VGT is an ETF that tracks US information technology companies
- VNQ tracks US REITs, which are companies that purchase office buildings, hotels, and other real property.
The (Dis)advantages of Investing in ETFs
A disadvantage of only investing in ETFs is that it's less volatile than holding individual stocks.
Well, I say disadvantage, but that really depends on your perception.
To me, and to a lot of people in the #FIRE community, it's actually a big advantage.
Differences in Volatility Between Individual Stocks and ETFs
There's way less volatility in ETFs, since a stock, individually, can lose half its worth in 24 hours, but, within an ETF, that loss is less because there are other companies who may have had a good day or year.
Let's take this Instagram post for example, from @personalfinanceclub. Let's also assume that I've invested $600.
In the case of individual stocks, I'd have invested $100 in each of those six companies.
- Google: $100 + 7% = $107
- Facebook/meta: $100 – 21% = $79
- Snap: $100 + 28% = $128
- PayPal: $100 – 23% = $77
- Amazon: $100 + 9% = $109
- Etsy: $100 – 9% = $91
Total portfolio: $591.
Whereas, if I took that $600 and invested it in an ETF, in this case VTI, it'd look like this:
VTI: $600 + 1.8% = $610.8
The point I'm trying to make is not necessarily that ETFs will always outperform holding individual stocks, since this is just a snapshot in time.
But notice those changes in percentages. Notice how different the volatility is with individual stocks compared to this ETF.
Stocks or ETFs: Which is Better?
Circling back to the main question of this article, which is better to invest in when you're a beginner?
The answer is simple, dry, black-and-white, and boring: none is better than the other.
The market returns, on average, 8% per year. So, that's stocks, ETFs, or both. 8% is 8%.
So this isn't enough to answer the question. What we also need to consider is…
The Simple Path to Wealth
As with anything you're thinking about of doing, there are two considerations you need to keep in mind.
- What is the long-term goal? What's your why? And what's the most frictionless way of getting there?
- How does it suit you?
Let's start with #1.
What is the long-term goal?
If you're on this blog, chances are that you're looking to retire early. And, hopefully, by now, you know that getting there is a long-term game that will probably take several years.
The road to financial freedom isn't flashy. Honestly, financial freedom, or at least the road to getting there, is boring.
- It's calculating your financial freedom number
- Track your expenses and cut down on what's unnecessary
- Increase your income
- Invest
- Wait (how long depends on which type of financial freedom you're pursuing).
- Retire early
But a ship sails best if it knows where it's going.
Whether it's a few years or multiple decades, there'll come a time when you've gone through steps 1 – 4 and then comes the long middle part that is step 5.
How does it suit you?
There's a case to be made for the concept of boredom, and how our current, at least Western, society isn't at all set up to allow for it. Everything needs to be a tweet, a quote, a vlog, a picture, a post. And all ideally with a clickbait-y headline or caption.
I truly believe this creates disturbing dopamine addictions in all of us. It's like we can't stay in a calm desert, but always have to kick up some sand.
As Ramit Sethi said in his book “I Will Teach You to be Rich”, don't live your life in the spreadsheets.
There's a time and place for them. And then there's also a required time and place to just live your life, and know that your roadmap to financial freedom is doing its thing.
When you're finally able to let go of all that, most of you will come to realize that you're not stock analysts, or born day-traders.
Some of you will be. And your personality actually matches with that kind of lifestyle: analyzing stocks, opening and closing positions multiple times a day. And more power to you.
Most of us, including myself, will hate the stress that comes with all of that. It's just not for us.
You need to take all of this into account when answering this question of if you should invest in stocks or ETFs.
- You want to become financially independent
- 99.4% (yes, that's made up) don't want to, or shouldn't, be in the stock market's weeds on a daily basis
Simple and Uncomplicated
Simple and uncomplicated are near-synonyms of ‘boring'.
They're also a synonym of what's going to be the best long-term (remember, multiple years – even decades) investment strategy for beginners who want to retire early.
So, what is it? What's the strategy? What's a good place to put your money?
2 great resources that helped me decide on this was JL Collins book “The Simple Path to Wealth”, as well as @financejosh‘s ebook on “The Easy Way to Invest”.
It's not in stocks. It's in ETFs.
In fact, it's in ETFs that capture big parts of the entire US and international markets.
JL Collins' advice is a 75% allocation in VTI (all US stocks) and a 25% allocation in BND (all US bonds).
Financejosh's advice mostly follows the principles of the Three-Fund Portfolio. This essentially covers the total US stock market, the total International stock market, and the total US bond market.
Allocation depends on your age, weighing more heavily towards the stock markets in your younger years, and, as you get older, weighing more heavily towards the bond market.
But all of these are a form of index investing, which I wrote a beginner's guide on.
If you're in the United States, reading/listening to those 2 resources can be enough for you to decide which strategy you're most comfortable with and then start.
If you're outside of the United States, you'll need to do some digging on similar ETFs that essentially track the same, but are more interesting for you to invest in, based on your location.
For example, in Belgium, and wanting to capture the total international stock market, a good ETF is the VWCE. This may also be true for other countries in the European Union, but this is where you need to DYOR (do your own research).
Start and Sit Back
Whichever ETF(s) you eventually decide on: start. As soon as you can. And once you've started, sit back.
Go live your life. Let the market do what it does. Which is, on average, go up, and get you closer to your financial freedom.
Which ETFs do you have a position in?
Disclaimer: I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only.
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