It’s an ETF Picker’s Market

by Jim Woods | February 1, 2013 12:28 pm

I am not a fan of clichéd market wisdom. As both a writer and an investor, cliché just offends my sensibilities.

However, one cliché you hear frequently from market pundits that I do concur with is the concept of a “stock picker’s market.” Basically, this means that while the market at large might be tough to predict, there are always going to be specific companies that will do well and outperform. The corollary here: It’s up to the investor to sort through these stocks and select the best ones.

But these days, I’d modify the phrase to say that this is an “ETF picker’s market.”

Let me explain.

Since the birth of the first exchange-traded fund[1] — the SPDR S&P 500 ETF (NYSE:SPY[2]) — 20 years ago this week, the universe of these specialized investment vehicles has blossomed into a banquet table for just about every investor palate. There are now more than 1,400 different ETFs to choose from, and collectively they’ve gathered some $1.4 trillion in assets.

Today, ETFs offer investors the ability to gain exposure to just about every market sector, country and region. You can find an ETF for every asset class, including equities, bonds and commodities of nearly all varieties. You also can find an ETF for every risk tolerance, as many funds now offer leveraged plays both on the bull and bear side of a given index or sector.

In the spirit of cliché abuse, I think the possibilities are endless with ETFs. In fact, I say that in some sectors, it just doesn’t pay to go stock shopping when you can buy the ETF instead.

Take defensive stocks, for example. Most investors buy defensive stocks for safety, dependability, a solid dividend yield and as a hedge against a wider economic downturn. The thinking here is that no matter what happens in the global economy, consumers still will need to buy toothpaste, cigarettes, soda, etc.

So, why buy several stocks such as Procter & Gamble (NYSE:PG[3]), Philip Morris (NYSE:PM[4]) and Coca-Cola (NYSE:KO[5]) when you can own all three — and 41 other consumer staple stalwarts — through the Consumer Staples Select Sector SPDR (NYSE:XLP[6])? With XLP, you get a yield of over 3%, and you get the diversification of owning stocks in a defensive sector.

This diversification allows you to avoid the company-specific risk inherent in buying a single stock. And though the upside potential in a stock that delivers a big earnings beat or offers up a new product is limited by your diversification, generally speaking, you are not buying defensive stocks for the big gains.

Another sector well-suited to an ETF over individual stocks is utilities. Here again, investors generally look to utilities to provide stable income and stable share prices during times of relative market flux. But in the case of utilities, a major storm or some type of natural disaster can shut down entire companies for weeks, and that can really slam the bottom line — and the share price.

East Coast power-generation firm FirstEnergy (NYSE:FE[7]) took a big hit from Hurricane Sandy, and the result was a nearly 10% plunge in the stock during the past three months. FirstEnergy happens to be a component in the Utilities Select Sector SPDR (NYSE:XLU[8]), which — thanks to its diversified portfolio of 33 utility companies — is up 0.2% over the past three months. This fund also delivers on the yield front, currently paying more than 4%.

Conversely, some sectors aren’t as conducive to the use of ETFs as others.

For example, if you are looking to get in on the next super biotech company mixing up the latest cure for cancer, ETFs aren’t the best way to go. Sure, there are ETFs that give you exposure to biotech, such as the iShares NASDAQ Biotechnology Index (NASDAQ:IBB[9]). But generally speaking, biotech investments tend to be shots at a big, quick score — and while the IBB can deliver great gains, its diversification isn’t going to result in a doubler in a matter of days.

The bottom line here is that ETFs can, in many cases, be better ways to go for investors looking for stability, income and yield than individual stocks. So before you go buying individual companies, it behooves you to check out the ETF alternative first.

As of this writing, Jim Woods did not hold a position in any of the aforementioned securities.

  1. birth of the first exchange-traded fund:
  2. SPY:
  3. PG:
  4. PM:
  5. KO:
  6. XLP:
  7. FE:
  8. XLU:
  9. IBB:

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