A recent survey sponsored by E TRADE Financial Corp (NSDQ: ETFC) and other brokers found that accounts with at least $1 million in assets usually allocate more than 30 percent of their capital to individual stocks.
Investors who manage smaller portfolios often put less than 20 percent of their cash in stocks and increasingly buy and hold index and exchange-traded funds (ETF).
Although ETFs enable individual investors to gain exposure to bonds, commodities, international equities and other asset classes that traditionally have been the province of professionals, far too many investors have abandoned individual stocks for fund products that promise one-stop exposure to a specific, sector, industry or strategy.
In other words, financial institutions and fund providers’ relentless marketing efforts have paid off for them, if not necessarily their customers.
Allocating too much of your capital to ETFs and index funds can weigh on the returns your portfolio generates via price appreciation and accumulated dividends.
Many ETFs overweight the largest-capitalization stocks in their portfolios, usually slower-moving blue-chip names. And the instant diversification that ETF marketing materials often tout usually means that you’re putting a portion of your money in some dogs, diluting your exposure to the underlying index’s big winners.
Consider the popular Market Vectors Oil Services (NYSE: OIH), which has generated a total return of about 12 percent over the past year. The ETF holds 25 stocks, weighted by market capitalization. Whereas the fund’s five best performers have gained an average of 49.1 percent over the past year, the bottom five have given up an average of 30.2 percent of their value.
With a 51.4 percent return over the past 12 months, Wealth Builders Portfolio holding Weatherford International (NYSE: WFT) ranks among Market Vectors Oil Services’ top performers.
Meanwhile, one of the ETF’s biggest losers, deepwater contract driller SeaDrill (NYSE: SDRL)—a name we told investors to sell in this free video—has plummeted more than 35 percent.
We’d rather own Weatherford International and sell it when the story starts to lose steam than buy and hold Market Vectors Oil Services, a mixed bag of winners and losers.
The instant diversification that ETFs provide comes at the cost of average returns; thoughtful investors willing to do the dirty work and pick stocks with the best prospects can generate superior returns—the very premise of this newsletter.