What is better than stocks or ETFs        

Numerous studies show that investors are more likely to make higher returns and avoid losses if they invest in several different stocks simultaneously. The more comprehensive the range of stores that investors own, the greater their chances of ultimate investment success.

The proportion of shares held individually increased to 13.5% of the total at the end of 2018 from an all-time low of 10.2% in 2008. Consumer research has also shown that individual stocks make up 63% of total assets on retail investment platforms, compared to 29% for funds.

But are these investors taking unnecessary risks instead of giving themselves the best chance of investment success?

What to choose, ETF SPY or VOO? 

According to the latest statistics, 92% of professional fund managers cannot beat the market.

In this case, “market” refers to the S&P500, an index of 500 large publicly traded companies in the US. Professional managers cannot make higher profits than this popular index over three years or more. And experience shows that the longer the investment period, the more likely it is to lose to the market. 

It is no easy feat because the S&P 500 has averaged 8-10% per year for the past few decades. But, of course, this included various periods of volatility where it could drop 40-50% before rising higher.

Analysis shows that if you had invested $10,000 in the S&P 500 in 1990, that would be $144,800 today.

When this type of investment grows over time, it can accumulate significant returns if you buy and hold it for years or decades.

For this reason, many legendary investors such as Warren Buffett recommend that most people don’t even try to pick individual stocks. Instead, they should put their money in an index fund that tracks the S&P 500.

It’s like buying a “basket” of 500 companies in the S&P 500 as if you own shares in all of them.

The easiest is to buy an exchange-traded fund (ETF) that tracks the S&P 500. These ETFs are financial products that hold the shares of all companies in the index, but ETFs trade the same way as stocks.

They also pay you dividends every three months, which you can reinvest to buy more ETF units. It increases the cumulative effect of your investment as the price of the ETF and the number of your shares increase over time.

We must note it should be pointed out that the ETF and index fund market is crowded, although there are a few popular options.

Consider the three most favoured S&P 500 ETFs – SPY, VOO and IVV.

SPY: SPDR S&P 500 ETF

Fund commission: 0.09%.

Dividend yield: 1.88%.

Assets under management: $275 billion.

The SPDR S&P500 ETF (SPY) is the world’s largest exchange-traded fund, with approximately $275 billion invested at the time of writing.

SPY was launched in 1993, making it the oldest ETF in the US market. Since its inception, it has been generating an average annual return of an impressive 9.28% per year.

Even though the expense ratio is slightly higher than VOO and IVV, active traders prefer it due to the increased trading volume. Seventy-eight million SPY shares are traded daily, compared to less than 5 million per day for VOO and IVV.

It means that it is easy to buy and sell large amounts of SPY without significantly changing the price of the ETF. This way, people can quickly get in and out of their trades at no extra cost.

In addition, SPY options are highly liquid and have very low ask-to-ask spreads, making them the preferred S&P 500 ETF for options traders.

VOO: Vanguard S&P 500 ETF

Fund commission: 0.03%.

Dividend yield: 1.89%.

Assets under management: $149 billion.

Vanguard S&P 500 ETF (VOO) is offered by Vanguard, founded by legendary investor Jack Bogle. He led passive investing through index funds, dramatically changing the investment landscape.

VOO has a meagre expense ratio of 0.03% and has averaged 12.81% returns since its founding in 2010.

IVV: iShares Core S&P 500 ETF

Fund commission: 0.04%.

Dividend yield: 2.07%.

Assets under management: $196 billion.

The iShares Core S&P500 ETF (IVV) is offered by iShares, a family of ETFs managed by Blackrock. This company is the world’s largest asset manager, with $6 trillion under management.

IVV has averaged 4.94% returns since its inception in 2001. The reason it’s lower than SPY and VOO is that returns from 2000-2009 were meagre with two substantial bear markets.

We don’t know why it has a higher reported dividend yield than SPY or VOO, but it seems to be some error in how returns are measured.

These 3 ETFs have very similar returns.

The table below shows three ETFs’ 1-, 3-, and 5-year returns.

	SPY	VOO	IVV
One year	3.7%	3.75%	3.75%
Three years	14.90%	15.00%	14.99%
Five years	10.80%	10.89%	10.87%

As you can see, all these ETFs have almost the same returns. But VOO and IVV should have 0.05% higher annual growth than SPY due to the lower expense ratio.

The chart below shows the comparative annual returns for each ETF since 2011 (blue is SPY, red is VOO, and yellow is IVV).

As expected, the earnings are mainly identical.

Which S&P 500 ETF should you choose?

As you can see from the statistics and charts, there is not much difference between the returns of these S&P 500 ETFs.

The most crucial difference is the cost ratio, as VOO and IVV are slightly cheaper than SPY and should account for 0.05% higher annual growth rates. It can make little difference in earnings if you buy and hold for several decades.

SPY is the best choice if you are actively trading ETFs or options on them, as it has the highest volume and tightest bid-ask spreads.

Here are options for what to choose

1. If you are an active trader or options trader, choose SPY.
2. If you plan to buy and hold, choose VOO or IVV.

We chose VOO as our S&P 500 ETF because I like Vanguard as a company, and we are happy to be doing business with them. But you will get the same income as IVV.

How many stocks should you hold in an investor’s portfolio?

Everyone knows you shouldn’t put all your eggs in one basket, as losing the whole basket would be catastrophic. The same rule applies to the stock market, so putting all our money in one or three stocks is risky. The question is how broad should our portfolio diversify.

Are eight stocks like Warren Buffett and other gurus enough in their portfolios, or should we hold more than 10?

To answer the question, you need to understand that there are two main risks when investing in stocks

Market risk

Also called “systematic risk”, it is the risk of losing money due to a macro event that is not directly related to the companies you hold. For example, sources of market risk include recessions, interest rate changes, currency changes, wars, political instability, coronavirus and more. In these cases, even stocks of companies that will not be affected by these situations will likely fall along with the rest of the stock market. Thus, unfortunately, there is nothing you can do to protect yourself from this global risk.

The risk to companies

The second risk (also known as “specific risk”) is the risk of losing money when buying shares in a company if something goes wrong. For example, you have acquired shares in a promising technology company that is expected to release next-generation fibres next year. Unfortunately, one of its competitors successfully produced and launched the duplicate threads six months earlier. Investors were very disappointed, and the stock fell 20%.

It can reduce the risk of a company by broadening your analysis of the company and the sector it belongs to before buying shares, but sometimes things don’t turn out the way you expected. So you can’t be 100% right on all your investment ideas, and on a few investments, you’ll lose money. Unfortunately, it happens to everyone, including Warren Buffett.

However, suppose we are holding only one stock, which has plummeted. In that case, we are losing a lot of money, but if we save 20 different stores at equal amounts and one of them has lost all of its value, we still only lost 5% from our entire value portfolio. In other words, diversification is excellent protection against company risks.

However, how many stocks should we hold to be fully diversified?

As we have understood, too few shares increase the company’s risk, but, on the other hand, too many claims will make it challenging to achieve above-market returns. The following simple test can help us determine the correct number of stocks to diversify decently.

If you buy all 500 shares of the S&P 500 at the beginning of the year, sell at the end, and repeat the process for many years, your average annual return will be about 10%, and the standard deviation will be about 20%. Statistically, this means that every 2 out of 3 years, your annual income will be 20% higher (30%) to 20% lower (-10%) than the average income. In other words, the US market volatility is 20%.

If you make a similar deal, but instead of buying all 500 stocks, you randomly select one store each time, your portfolio will have almost 50% volatility. It is more than double the market volatility and is too high for most investors.

However, as you can see in the figure below, as the number of stocks increases towards 12-20, volatility drops sharply, only a few per cent above market volatility. So buying 12 to 20 shares will not make your portfolio immune to market volatility.

Indeed, looking at the portfolios of successful investors like Warren Buffett and other gurus, you see 8-15 stocks in their portfolio, which is proper diversification. On the contrary, mutual fund managers do the wrong thing, usually including more than 50 stocks in their funds, which reduces portfolio volatility somewhat but prevents them from beating the market. As a result, their net income after deducting management fees usually falls below market income.

To summarize, it should note that if you are a novice investor without much experience, it would be wise to include about 20 stocks in your portfolio, investing equal amounts of money in each store. The more thorough your analysis and experience, the fewer shares you need to hold (but probably at least 12) and even more money to invest in your best ideas. Buying 12 to 20 stocks will allow you to make higher returns than the indices, keeping your eggs in separate baskets and protecting you from significant losses if you buy multiple underperforming stores.

ETFs are apparent advantages

One of the advantages of investing in funds is that they are ready-made portfolios containing a wide range of stocks. They provide investors with instant diversification. If some stores perform poorly, losses can be offset by gains elsewhere in the fund. It helps reduce the risk of the fund compared to a single share while increasing its expected growth.

Investors in individual stocks are less likely to receive the higher returns that stocks have historically generated over extended periods in exchange for more risk.

Of course, nothing can stop you from building your stocks portfolio if you think you have the foresight to choose companies that can provide the best investment returns – just like many professional active fund managers. After all, finding the following big winners is every investor’s dream, making life a little more interesting.

However, successful success stories are not only rare but also hard to find. For example, one well-known study published in 2018 found that just 4% of all listed US companies have accounted for the entire net income of the US stock market since 1926.

Even professional investors, on average, have a mixed reputation when looking for stocks that outperform the market and a poor experience of consistently looking for them.

Successful long-term investing is not so much looking for needles in haystacks as it is investing in the haystacks themselves.

That is why ETFs increase your chances of beating the market, or at least following it, in the case of, for example, funds that target the S&P 500 index.

How many stocks to hold in a portfolio

But if the goal is to improve your chances of successful investing by buying a wide range of stocks, how wide should it be?

How many companies do you need in this basket? 5? Ten? Thirty? Fifty? The answer, studies show, is much more than individual investors realize.

The more shares in the portfolio and the more diversified it is, the more successful the implementation of any investment strategy and investment experience will be. 

The fact is that, despite its potential appeal, individual stock selection is unlikely to be the right decision, especially for novice investors, let alone outperform the market in the long run.

No wonder they say – “do not put all your eggs in one basket.” Instead, make sure your investment is widely distributed.

And don’t forget to keep your costs down, especially those associated with frequent buying or selling of individual stocks, because the lower your expenses, the more of that long-term profit you can keep for yourself.

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