The Search For A Low Expense Ratio Ends Here

March 27th, 2015
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Sungarden Investment Research Article of the Week

by Rob Isbitts, Sungarden Investment Research

Amidst the industry noise, the benefits of using individual stocks stand out

Over the last 40 years, an investment evolution has occurred for the retail investor and their financial advisor. From stockbrokers chatting up stocks and bonds, to mutual funds and separately-managed accounts (SMAs), to ETFs and other varieties, the high net worth and emerging wealthy (say, for portfolios of $200,000 or more) have plenty to choose from.

Follow up:

Perhaps they have too much to choose from. But to us at Sungarden, having experienced the evolution first hand ourselves, we see the benefits to many investors in coming full circle, minus the over-priced, low-yield, high-potential downside of high-quality bonds. As we see it, the investment of the decade is not mutual funds or ETFs. It is individual stocks. You may just not realize it yet. Here is why:

  1. There are so many "pooled" investment products that the danger of oversaturation of the investor exists. When everyone's in the "pool" it is time to start thinking about getting out. It could get dangerous in there. By no means am I saying that mutual funds and ETFs are not viable investments. But Wall Street has a tendency of feeding its audience more and more of the same thing, until it explodes like the large fellow at the end of Monty Python's movie "The Meaning of Life" (if you don't get the reference, don't worry ... its quite grotesque). We may be approaching that point.
  2. A portfolio of individual stocks can be hedged with precision. For instance, if you own a group of stocks and understand what is likely to influence their movement, you can hedge with an inverse ETF. In combination, you have a "net equity exposure" you can adjust as your market outlook changes. Thanks to the flexibility of ETFs, stock market risk can be managed better today than in decades past. Inverse ETFs and even options (which have also gone more mainstream), can be used as effective volatility modifiers alongside an equity portfolio.
  3. Individual stocks can be less expensive to own. Unlike funds, they don't have expense ratios and continuing trading costs. It seems that a more critical and cost-sensitive public, who pay more attention than ever to expense ratios (witness the popularity of Vanguard and Dimensional Fund Advisors funds), will likely appreciate the increased focus on keeping non-advisory costs low. And who doesn't love a proactive financial advisor?!
  4. Finally, there is the aspect of familiarity. Show a client a list of portfolio holdings with names like "Disciplined Growth," "Lifestyle 2025" and "Alternative Alpha" and they are likely to tune out and miss the point of what you are trying to do for them. They will check out emotionally and not identify with what their life savings has been placed into. But show them a list of real, live companies, including some names they may know and industries they feel strongly about (as investors, people, or both), and I think you have a better chance of having spirited, productive consultations at all stages of the relationship. After all, if you believe as I do that while ETFs and mutual funds deserve to be included in the mix, but individual equities at the core is the way to go, that's more of an evolution following decades of dominance by pooled products.

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