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?
As a beginner investor, I decided to start with one of each. I put $500 into a dividend-paying stock that has growth potential, and $500 into a dividend-paying ETF. I plan to hold both for at least a year to learn about how a stock and an ETF fluctuates, and what the returns start to look like based on how I picked my stocks. I’m fairly certain that neither the stock or the ETF will be experiencing huge losses over the next year, and I plan to only buy stocks when I’m investing $500 or more (keeping the $5 trading fee at 1% or less of my total purchase).
One thing I did not know about and learned the hard way is to watch out for ECN and ATS fees. I wrote a blog post about the experience if anyone is interested:
I used to invest in stocks but gradually am moving to ETFs as a core portfolio… mostly because researching stocks is a lot more time consuming than researching a sector…
I can play short-term using leveraged ETFs
if you are a pure dividend investor you can not fall into the trap and invest in a company just for the dividend.
you want companies that grow their dividend over time that alos have renenue growth and their dividend payout needs to be less than earnings for the most part
with our dividends the sandp return would be cut in half
Our Life Inc.
Two comments on this post:
First, in my own experience, I saved my money while I learned how to invest. I think this is the way to go if you want to invest in individual stocks. It is not diificult to pick good dividend stocks and it is not hard to learn about it either. If you have the time and the motivation, you can learn and read quite a bit over a year. By the time I was comfortable in my ability I purchased Wal-Mart and Fifth Third. Wal-Mart has done it’s job with the dividend, however Fifth Third took me for a ride. Yet, losing about 80% of my initial investment was really a payment towards a good education. I put $500 into FITB and got $100 out. $400 well spent with respect to what I learned from that experience.
Second, you mention GE quite a bit and getting burned by it. You also talk a lot about beginner investers. In my opinion, and it is slightly biased since I bought GE right after the dividend cut, GE is not a bad company and not a bad company to own for a young dividend investor. Getting in at the right price should give an accumulator like myself plenty of time to participate in a growing dividend that is sure to happen (it increased by 20% this quarter). I know many investors, such as Dividend Growth Investor, have rules to sell after a cut, however I prefer to take these situations on a case by case basis. An argument can certainly be made that GE is a good dividend growth stock for the future, particularly if you have a decade to watch it grow it’s payment.
Anyways, my two cents. Good post.
I prefer to know as much as I can about the specific companies that I am investing in.
Not all dividend payers are equal in value or in regards to future prospects or debt level: any new investor can learn these basics very quickly. I was able to, and I still have plenty to learn; anyone who holds stocks in any form needs to learn these things. Why not at the beginning?
For small investors (which I classify as under $100k in investments) or individuals with little time for detailed analysis, I believe ETFs is the better solution.
The ability to diversify is a key factor in favour of the ETF. The events of the previous few years has shown that black swan events can and will occur. Even the most thorough analysis cannot identify those events. While we may give up some dividend growth by going the ETF route (since the ETF may contain several slow/no dividend growth stocks), the elimination of company specific risk is worth it IMHO.
Wow! I was surprised to read that you, the dividend guy, are suggesting buying stocks as I think you have said that a core portfolio of ETF’s is best. I love your 3 major lacks – so very true. I have found that it is highly emotional to buy stocks because one never knows, or it is hard to pin point, the best entry point. I definitely look for dividend growth. I try to diversify. I also try to buy solid big companies that have an excellent track record and buy them with the thought that I will never sell. That being said, just buying a dividend ETF often seems like an attractive alternative.
How much do you reckon a person should spend on each stock purchase: 500? 1000? 2000? 5000?
I have helped several friends and the odd employee to develop a savings and investment program and for the beginning investor I don’t even worry about returns. First it’s about developing savings habits and learning to accumulate investment capital. Save the $100 a month just about anywhere from an ING account to your mattress and spend the time while you’re accumulating an investment grubstake to learning where to get better returns such as dividend producing stocks or ETF. Once you have at least a few thousand dollars you might consider focusing on returns. For the beginner who hasn’t got a savings habit anything accumulated is 100% return. Ultimately I’m a fan of good dividend producing stocks.
Why does it have to be one or the other? Stock picking or etf’s?
I have both in my portfolio. If one is investing on a budget…and pretty much anything under $100K is a on a budget….etf’s are a valuable way to go for part of one’s portfolio.
But, as with stock picking, it’s important to select the correct etf’s as well…n’est pas?
I was one of those advocating picking 3 stocks of $333 each.
You make a good point that you can pick the wrong stock like a GE. I have to agree with “our life inc” in that you dont have to invest right away. Neither stock nor etf is going to make you rich in the first month or two.
If $1000 is burning a hole in your pocket that you have to invest then it probably doesnt matter what you pick it will be for the wrong reasons.
I’ll stick with ETF DVY, makes life simple, I don’t want to manage my own personal mutual fund. With DVY I have many undervalued income stocks in 1 fund, easy to keep up with. I know I’m over 1 year late leaving a comment, but better late than never.