Why I pick stocks for my portfolio instead of investing in a FTSE 100 tracker fund

FTSE 100 (INDEXFTSE: UKX) tracker funds have become very popular with investors in recent years. Yet stock picking could be a far more profitable strategy, says Edward Sheldon.

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In recent years, exchange-traded funds (ETFs), which track a market or index, have become very popular with investors. So much so that a lot of investors today don’t even bother trying to pick stocks any more. Why go to all the effort of stock picking, when you can just buy the market through an ETF?

It’s a fair question. Especially when you consider how hard it is to consistently beat the market. That said, while ETFs have their advantages, I still believe there’s a place for stock picking today. Here’s a look at why I prefer to pick individual stocks for my portfolio, rather than invest in a FTSE 100 tracker fund.

Outperformance potential

For starters, one of the reasons I prefer to pick stocks is that there are many stocks within the FTSE 100 that I don’t want to own. I’m talking about the kinds of companies that are highly leveraged, or at risk of cutting their dividends. A good example is BT Group. BT has a huge debt pile, a massive pension deficit, and its dividend looks unsustainable. In short, it’s a low-quality stock. Now, if I buy a FTSE 100 tracker, I’m stuck with exposure to BT. However, by picking my own stocks, I can avoid it. And by avoiding low-quality companies, I give myself a chance of beating the market over time.

Higher yield

Secondly, by picking individual stocks I can construct a portfolio that has a higher yield than the FTSE 100. Right now, the FTSE 100 has a median forward-looking dividend yield of 3.9% according to Stockopedia. However, my own dividend portfolio has a yield of 4.4%. Ultimately, that means I’m picking up more cash dividends every year than I would if I was invested in a FTSE 100 tracker.

Dividend growth

To obtain a high yield, I’m not sacrificing dividend growth either. My investment strategy, in general, is to focus on companies that are increasing their dividends regularly. Examples include stocks such as Unilever, Diageo, and Prudential. This means that my income stream is likely to grow faster than it would if I was invested in a FTSE 100 tracker. Many companies at the top of the FTSE 100 such as Royal Dutch Shell, HSBC, and GSK haven’t increased their dividends for years which means that dividend growth for the index as a whole is not likely to be high.

Life-changing returns

Finally, I’ll point out that at the smaller end of the market, stock picking also provides the potential to generate life-changing returns. For example, look at online fashion retailer Boohoo. A £2,000 investment there four years ago would be worth around £20,000 today. You’re never going to get those kinds of returns by investing in the market.

So, in summary, while ETFs do have their advantages, I continue to see plenty of appeal in picking individual stocks. Whether your goal is a higher dividend yield than the market or explosive returns from small-caps, stock picking can be extremely rewarding if you’re willing to put in the effort.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Edward Sheldon owns shares in Unilever, Diageo, Prudential, Royal Dutch Shell, GlaxoSmithKline and Boohoo Group. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline and Unilever. The Motley Fool UK has recommended boohoo group, Diageo, and Prudential. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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