Part of asset allocation investing involves deciding what is the best or optimal mix of investment vehicles; stocks, ETFs, or mutual funds, for your portfolio? Each has advantages and disadvantages that can affect your investment portfolio and long term investment returns.
Investing in individual common stocks or bonds gives the investor the most flexibility to target specific companies that fit the individual’s particular investment style. It also makes it possible to own the best opportunities or best companies to invest in. Low commission rates make transaction costs and lower expenses another advantage. The main disadvantage is the need to properly diversify a portfolio to the point of reducing unsystematic risk (specific risk) but not participate in overdiversification. Both under diversification and over diversification are causes for poor portfolio performance.
Exchange Traded Funds (ETFs) provide diversification by owning a basket of securities, and trade on a stock exchange like a stock. ETF’s can segment to very specific or targeted sectors, allowing investors to have a diversified position in a small slice of a sector, and generally have lower expenses than mutual funds. ETF disadvantages include the fact most ETFs are programmed to follow a specific index. The index, and therefore the ETF, may not own the very best stocks.
Equity and bond mutual funds are losing market share to ETFs and individual stocks and bonds due to the lower costs of individual transactions and the advantages of ETF investing. Equity mutual funds, in general, have been poor performers in the last decade due to over diversification and high expense ratios. Mutual funds are still a viable choice for investors with a small amount of investment capital and in rare cases where you have an exceptional fund manager worth the extra expense.
The Arbor Asset Allocation Model Portfolio (AAAMP) uses a combination of individual stocks and ETFs in its’ allocation of assets. ETFs are used to obtain diversification in industries where the portfolio wants broad exposure in specific sectors. Individual stocks are used to purchase companies with one or more strategic advantages. Examples of strategic advantages might include proprietary products, excellent management, strong balance sheets, high and/or growing cash flow, a geographic monopoly, demand driven by a strong global trend, etc.
The goal is to use the investment vehicle that best meets the objective of a particular investment and allow the portfolio manager to keep expenses low and achieve an optimal asset allocation.
This article was featured in the Stock Carnival Ecstasy.
| AAAMP Blog by Ken Faulkenberry | |
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Ken Faulkenberry earned an MBA from the University of Southern California (USC) Marshall School of Business with an emphasis in investments. Ken has 25 years of investment experience and is dedicated to helping people with self-directed investment management through the Arbor Investment Planner. His asset allocation strategies have an outstanding performance record. |
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