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.

The post Why I pick stocks for my portfolio instead of investing in a FTSE 100 tracker fund appeared first on The Motley Fool UK.

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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.

However, the rise of exchange-traded funds (ETFs), or index/tracker funds, in recent years has completely changed investing. Through an ETF, you can get exposure to a whole market or index with just one security at a very low cost.

Is investing through an ETF a better idea than picking stocks though? Let’s take a look at each strategy.

Index investing

ETFs offer investors a number of benefits. For a start, they make investing a very simple process. Through just one security, you can get exposure to a whole index, whether that’s the FTSE 100, the S&P 500, or the China Shanghai Composite index. Given that it’s very hard to consistently beat the market, buying the market itself through an index fund makes a lot of sense.

The other main advantage of tracker funds is their cost structure – fees are generally very low. For example, through online broker Hargreaves Lansdown, you can invest in the Legal & General UK Index fund – which tracks the FTSE All-Share index – for just 0.04% per year. Keeping your fees low is important when investing in the stock market, so tracker funds have considerable appeal from a cost perspective.

On the downside, however, index funds provide you with very little flexibility as you’re forced to own every stock in the index you’re tracking. Not a fan of companies that manufacture weapons? If you own a FTSE 100 or S&P 500 tracker, you’ll have exposure to them.

The other drawback of index funds is that, by definition, you will never ever beat the market. That may not be an issue when the market is rising, but what about if the market is falling, or trades sideways for a decade?

Picking stocks

Stock picking also has its pros and cons. One of the big advantages of picking your own stocks is that it gives you flexibility. If you want to construct a portfolio that has a higher yield than the index, you can. If you want to avoid tobacco stocks for ethical reasons, that’s easily done. When you’re picking your own stocks you have far more control over your portfolio.

Picking your own stocks also provides the potential to generate life-changing returns. For example, had you invested $5,000 in Amazon a decade ago, that investment would now be worth around $114,000. Of course, not every stock performs this well, but the point is you’re not going to get those kinds of returns from index investing.

On the downside, stock picking does require time and effort. It takes time to thoroughly research companies, and you need to have a basic understanding of investing as well.

Ultimately, both strategies have their advantages and disadvantages. If you don’t have much of an interest in investing and you’re simply looking for exposure to the market at a low cost, an index fund could be a great choice. On the other hand, if stocks do interest you, and you think you could potentially beat the market, stock picking could be a good option.

The post Picking stocks vs index funds. What’s the best investment strategy? appeared first on The Motley Fool UK.

More reading

• A SIPP seems to offer investors free money – is there a catch?
• Here’s what £10,000 invested in Greggs shares a year ago’s worth now
• Recent BT share price performance is jaw-dropping but can it continue?
• Is the stock market correction a once-in-a-decade chance to target a million-pound SIPP?
• How to target a £10k annual income from just one year’s £20,000 Stocks and Shares ISA allowance

Edward Sheldon owns shares in Hargreaves Lansdown. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Amazon. The Motley Fool UK has recommended Hargreaves Lansdown. 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.