Is there any reason to own an individual stock anymore?
Posted January 24, 2020 12:57 p.m. EST
CNN — The stock market has been on fire for the past year and keeps hitting new record highs. So who needs fund managers to pick individual stocks?
Investors now get their market exposure through the many passively-run exchange traded funds that mimic the performance of such big indexes as the S&P 500 and Nasdaq-100.
Those funds own all the big tech stocks that have helped lead the market higher, such as Apple, Amazon, Facebook, Google owner Alphabet and Microsoft. Costs tied to these ETFs are minimal, making them less expensive than actively managed funds that tend to charge hefty fees.
That's great news for asset managers like BlackRock, the owner of the popular iShares family of ETFs. BlackRock said in its most recent earnings report that iShares brought in more than $75 billion in new money during the fourth quarter.
Even legendary investing guru Warren Buffett has lamented that it's harder for stock pickers to outperform passive ETFs. The Oracle of Omaha told CNBC last year that he's had a "tough time" trying to beat the S&P 500.
With that in mind, Buffett wrote in his 2013 annual shareholder letter to Berkshire Hathaway shareholders that in his will, the trustee of his estate is instructed to put 90% of the cash Buffett is leaving to his wife in a "very low-cost S&P 500 index fund" and the rest in short-term government bonds. (Buffett specifically suggested that the Vanguard S&P 500 ETF.)
"I believe the trust's long-term results from this policy will be superior to those attained by most investors -- whether pension funds, institutions or individuals -- who employ high-fee managers," Buffett wrote.
Given how well the market overall has done over the past decade, it's a gamble for investors to put all retirement money into individual stocks or mutual funds that might underperform the broader market.
Don't abandon active funds just yet
Still, some experts continue to advocate picking individual stocks or mutual funds instead of ETFs. "The reason people say active investing is dead is because passive funds almost always outperform in bull markets, and this is the longest ever," said Randy Frederick, vice president of trading and derivatives at the Schwab Center for Financial Research.
Frederick pointed out that many active funds performed better than passive ETFs in December 2018, when the broader market plunged to near bear market status due to worries about the Federal Reserve raising rates too aggressively.
He isn't predicting a big market crash anytime soon. But long-term investors worried about volatility should have no more than 20% of their portfolio in actively-managed accounts.
"Don't confuse a bull market with investment prowess. Everyone is a genius in a bull market," Frederick said. "Active managers earn their pay when things get rocky."
Since the bull run won't last forever, investors should prepare for an eventual downturn. That's when stock pickers like Warren Buffett should shine.
"I'm not anti-passive investing. But the active management strategy has been unjustly vilified," said David Lafferty, chief market strategist of Natixis Investment Managers.
Lafferty said that many active managers have been building cash positions to take advantage of market sell-offs. They are more likely to invest beyond the Big Tech names that are over-owned in index ETFs.
"Once people learn the market doesn't always go straight up, there could be a newly-found appreciation for the ability of an active manager to outperform," Lafferty said. "Smart investors will stay active in order to have a chance to protect themselves from losses."