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ETFs, Stocks, or Mutual Funds: Where Should You Invest

By Mohit Oberoi, CFA - Published 2 months ago - 2 months ago 0 Comment
ETFs, Stocks, or Mutual Funds: Where Should You Invest
  • ETFs have gained a lot of traction since the 2008-2009 global financial crisis. While ETFs account for a large chunk of investor portfolios in developed countries like the US, there share in investor portfolios is relatively smaller in emerging economies like India.
  • Meanwhile, there is the age-old debate over what is better, ETF, stock investing, or active fund management strategies. We’ll try to answer this in this article.

Warren Buffett on ETFs versus stocks

In this year’s annual shareholder meeting, the legendary investor and Berkshire Hathaway chairman Warren Buffett advised buying ETFs. Buffett expects Berkshire to outperform the S&P 500 by only a slight margin. According to Warren Buffett, “I don't think most people are in a position to pick single stocks.”

Coming back to our question as to whether one should buy stocks or ETFs, Buffett’s statement best answers that question. Investing in stocks involves a lot of research and requires three main things. Time, expertise, and temperament. Out of the three, temperament is the main aspect in my view. As I noted previously, this is what separates Warren Buffett from other fund managers.

Key features

To sum it up, if you have some basic knowledge about finance, can spare time towards researching companies, and most importantly are prepared to patiently understand the business and mentally prepared to see the stocks go down in value, then only you should consider investing in stocks. It's worth noting that investing in stocks is riskier as compared to investing in an index. The index is diversified across sectors and companies and adds a natural diversification to your investing.

ETFs versus actively managed funds

Now, let’s come to the second question on active fund managers versus passive investing. Active fund managers charge a higher fund management fees as compared to ETFs. The higher fees are supposedly for investing strategies that can deliver alpha or better risk-adjusted returns for investors.

However, at least in the United States, many active fund managers have failed to beat the index. The scenario, however, is different in India. Most active mutual fund managers have delivered returns that are better than the index

The anomaly in ETFs versus active fund management in the US and Indian context can be due to two reasons. Firstly, US markets are much more efficient than Indian markets. Secondly, we may need to benchmark active fund managers against a more representative index for Indian markets.

Why advisors don’t recommend ETFs much

The Nifty has 50 stocks while the Sensex has 30. The S&P 500 has 500 stocks and is much more representative. While there are indices like the BSE S&P 500 in India, they are not as tracked and hence not much benchmarked against.

But then, coming back to ETFs, not many financial advisors recommend them. This time, the scenario is no different in India as it is in developed markets. Looking for a reason? It's straightforward as Warren Buffett bluntly put it “You don't make a lot of money advising an S&P 500 Index fund.”

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