Introduction
Do you think a 16% return is better than a 2% return? It seems like an obvious answer, yet many investors keep flocking to individual stocks, hoping for the next big thing, only to be disappointed by a measly 2% return. The truth is, the world of investing isn’t that simple, and a lot of us are making mistakes we don’t even realize.
That’s why in this in-depth analysis, we’re comparing investing in an ETF (Exchange-Traded Fund) against investing in individual stocks. We’ll take a look at how they perform, delve into actual facts and figures, and discuss why some investors might be setting themselves up for failure. I’ll also reveal a personal investing mistake I made that led me down the wrong path. So grab a coffee and read on; this is going to be a comprehensive guide.
Basic Details of a Stock vs. ETF
In simple terms, when you invest in a stock, you are buying a piece of an individual company. Your earnings depend on how well that company does. With ETFs, you’re investing in a collection of stocks, bonds, or other assets, depending on the fund’s makeup. ETFs can be passively or actively managed. While an actively managed ETF has a fund manager who makes buying and selling decisions based on analysis, a passive ETF simply tracks an index of stocks or assets.
There are pros and cons to both approaches. ETFs can provide diversification, reducing risk if a particular company or sector tanks. Stocks, however, offer the lure of high returns if you pick a winner. The caveat? You could also lose big.
The Allure of the Nasdaq 100 Index
Among the multitude of indices out there, the Nasdaq 100 is one that stands out for me. It includes the top 100 non-financial companies, usually from the tech sector. ETFs like QQQ (or QQQM) make it easy for the average investor to gain exposure to these companies without having to buy each stock individually.
The beauty of an ETF like QQQ is that it self-cleanses. Underperforming companies get booted out of the index, replaced by higher performers, without you having to lift a finger. You continue to hold a diversified, dynamically updated portfolio by merely owning shares in the ETF. This is why I invest $5 a day in the S&P 500 too!
When a Company Fails (Bankrupt)
A perfect example of why the cleansing process of ETFs is beneficial is when a company goes bankrupt or underperforms drastically. For instance, if you had all your investment in a company like Circuit City, which went bankrupt, you’d be out of all your money. This happened to me, and I’ll tell you it’s not a pleasant experience.
However, if Circuit City had been part of an ETF you owned, the fund would have automatically removed it when things started going south. You might see a temporary hit, but your other diversified holdings would offset that loss.
My Bad Investing Mistake
My investing journey wasn’t always smooth sailing. Back in 2005, I decided to invest in Circuit City without doing adequate research. The stock soared initially, only to collapse, leaving me with dead shares and a bruised ego. My mistake? Not diversifying and investing all my money into a single company, thinking I was riding a wave that would go on forever.
The Gamble of Individual Stocks
Investing in individual stocks is similar to betting on a single number in a game of roulette. You may win big, but you could also lose everything. Unlike an ETF, where your investment is spread over various companies, a single stock exposes you to high risk, as I learned the hard way.
How We Will Compare ETFs vs. Stocks
For our analysis, we’re going to use real-world data. We’ll look at the performance of the QQQ ETF, which tracks the Nasdaq 100 index, from 2010 to 2023. We’re assuming an initial investment of $10,000 and will compare the performance of QQQ against some of its major individual holdings over the same period.
How to Find Prior Holdings (Wayback Machine)
Now, one issue with tracking ETFs over time is the inability to see historical holdings easily. But fear not, there’s a workaround. Websites like the Wayback Machine can show you what an ETF’s holdings looked like in past years. You could use this to measure how your investment would have performed had you invested in individual stocks of the same ETF.
Check out the Video for the Visual Details:
Conclusion
So what’s the takeaway? If you’re looking for a hands-off, diversified approach to investing, ETFs like QQQ offer an excellent option. Their self-cleansing nature ensures you’re not left holding the bag when a company goes bankrupt, as I did with Circuit City.
However, if you’re confident about your stock-picking skills, individual stocks can offer potentially higher returns. But remember, the higher the reward, the higher the risk.
Invest wisely, and may your portfolio flourish.
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