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Why Most Investors Should Stick To ETF Investing

Jan. 22, 2016 5:39 PM ETiShares Core S&P 500 ETF (IVV)SPY, VOO
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Summary

  • Most investors are unsophisticated.
  • Most investors lack company and industry knowledge.
  • Over time an ETF strategy will produce superior returns for unsophisticated investors.

Investing is an exercise that allows any individual with capital to enter the market with a hypothesis and capital with the hope for capital appreciation and/or dividend income. The market has no barrier to entry for intelligence, education, risk tolerance, etc. Most individual investors that are without an education in finance or accounting lack the knowledge to truly understand what drives a company. Yes, investors can seek to increase their knowledge independently through books and reading annual reports. It cannot be disputed that a significant amount of these "uneducated investors" lack the discipline and/or time to increase their knowledge to the point where "intelligent investments" can be made.

Investors that are lacking the accounting and finance background lack the knowledge to perform an adequate valuation. Again, investors are able to self-educate, but many will not. Therefore, investors will be shooting in the dark trying to find a reasonable price to purchase a security. Every stock requires a level of finesse to adjust the valuation for various risk-free scenarios (i.e. the impact of an interest rate increase by the Federal Reserve impact on the 10 year). Furthermore, betas used in a discounted cash flow model at times need to be adjusted when at irrational levels.

The "uneducated investors" that lack the desire or ability to fully understand businesses should pursue a passive strategy of investing in exchange traded funds (ETF). Three exchange traded funds that investors should perform their due diligence on is Vanguard's (VOO), State Streets SPDR (SPY), and Blackrock's iShares (IVV). These funds will mimic the overall performance of the S&P 500 and the overall market.

State Street SPDR has a gross expense ratio of 0.1098 percent and a net expense ratio of 0.0945 percent. SPY yield of 2.24 percent is slightly lower than S&P 500 of 2.36 percent. Below is the top holdings of the fund in comparison to the S&P 500. The holdings are very similar with minor variations.

(click to enlarge)

Source: State Street

Vanguard's VOO has an expense ratio of 0.05 percent, which is stated to be 95 percent lower than the average expense ratio of comparable funds. The fund has an SEC yield of 2.12 percent. Below is the sector and holdings breakdown for VOO. It can be seen that the sector breakdown for VOO and the S&P 500 is identical.

(click to enlarge)

Source: Vanguard

Blackrock's iShares has an expense ratio of 0.07 percent. The fund has a 30 day SEC yield of 2.05 percent and a 12 month trailing yield of 2.26 percent. The iShares fund has the second highest expense ratio of the three funds. It can be seen below that the composition of the fund is identical to the other funds

Source: iShares

Overall, the best option of the three S&P 500 exchange traded funds is Vanguards . Investors who do not have the time to learn about businesses nor have the adequate background should pursue this strategy. Additionally, this strategy eliminates an individuals need to try to "time" the market.

Analyst's Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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