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Which option offers the most return for retirement:investing in an index ETF or a high yield fortune 500 company stock?

Jan 16, 2012 by alex from San Diego, CA in  |  Flag
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9 votes

Neither by itself would be good for retirement investing. Diversification is the key to risk management, and risk management is essential to proper management of investments. Having a portfolio that is up 10% one year and down 10% the next works out better than one that is up 50% is one year and down 50% the next. While they have an average return of 0% over the two periods, $100 invested in the first ends up as $99, while the same $100 in the later is only $75. Therefore, proper investment management cannot only be thought of in terms of return, but must also consider risk. Another way of looking at it, if I get an 8% return from a bond fund, that could be considered pretty good, but if I get the same 8% return from an emerging markets stock fund, I haven’t done so great. The differentiator is the risk taken to get the result. So risk, especially in retirement where we do not having earning potential any more, should be considered as well as return. A well-versed advisor should be able to help evaluate those components, but I will say this – any equity only positions (as in your two choices) without other types of investments is too much risk for the vast majority of retiree’s. that being said, and a direct response to your question: Which would provide the most return would depend on which index ETF as opposed to which Fortune 500 stock. If we narrow it down to specifics, we can give an answer in hindsight, but can only predict what will be in the future. Best luck in finding sound solutions…

1 Comment   |  Flag   |  Jan 17, 2012 from East Dundee, IL
Dylan

I like your example, it helped to see the math behind the 10% vs 50% swings.

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Flag |  Jan 18, 2012 near Houston, TX

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7 votes

The answer would depend on how well your crystal ball works. Both have the future potential to outperform the other, but they are two different types of investments. Most professionals would agree that since none of our crystal ball theories tend to work out, it is most prudent to build a portfolio utilizing proper diversification. This is where the argument for mutual funds comes into play. The idea, at a high level, is for people to buy a mutual fund that invest in several stocks rather than buying just a few stocks on their own. An ETF is a type of mutual fund that you can buy and sell like a stock but has several underline stock holdings inside of it. They have exchange traded funds for just about every possible stock market segment identified by man, so they are very useful tools in building a fully diversified portfolio. If you bought Exxon, Apple and IBM vs. an ETF investing in the entire S&P 500 Index one of three things would happen. Those 3 stocks collectively would outperform the 500 index, do about the same or under perform. I would suggest figuring out your correct mix of high risk vs. low risk investments, then consider low cost ETFs to build your portfolio. The average investor has substantially underperformed the S&P 500 index and to many investors surprise, the experts haven’t done much better. You would be better off trading in the hope for outperforming with not under performing, and utilizing a passive investment approach that can be achieved with exchange traded funds or other similar investment instruments.

Comment   |  Flag   |  Jan 16, 2012 from North Richland Hills, TX

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3 votes

All great answers. It's a fascinating question which would indeed require a crystal ball to answer accurately. I will say this: as others have pointed out, which the data confirms, investing in any individual security brings more risk then buying the entire index it sits in through an ETF. About 3 times the volatility with no added return ( on average). Of course you may pick one of the outliers that significantly outperform - but it's unlikely. I am definitely on board with Victor in creating a thoughtful plan before deciding on investments Finally, when it comes to "retirement investing", I wouldn't think as much about yield as I would total return. As David Loeper pointed out: "a dollar spent from a capital gain buys the same amount gas or grocery's as a dollar spent from a dividend". (Maybe more because it's taxed less) Feel free to reach me with any questions on this. Evan 917.696.0674

Comment   |  Flag   |  May 16, 2012 from Port Washington, NY

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1 vote

Alex, I think there is a question behind your question; if I'm correct you are asking if you should invest only is high dividend paying stocks. While dividends are great, only about 25% of domestic companies pay a dividend. So that strategy would limit your stock universe to large established hopefully, profitable companies possibly leading to under diversification. By doing so one would forgo investing in companies such as Apple and Google which have yet to pay a dividend. That strategy would also not include investments in most small and midcap companies, emerging markets etc. Remember at one time companies such as Kodak, GM etc paid a hefty dividend!

1 Comment   |  Flag   |  Jan 25, 2012 from Cleveland, OH
Kevin

Investing in a single stock has much MORE risk than buying a basket of items in an ETF. Step 1: how much risk are you prepared to weather? Who should select the allocation of the portfoilio. For most people, they are better off having a Third Party Money Manager make that selection for them. Then monitor and adjust the allocation to ongoing market conditions.

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Flag |  Jan 25, 2012 near Orange, CA

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1 vote

Alex, unless you are prepared to live of the fluctuating dividend yield from a single stock or a large-cap ETF, you are putting your retirement security at risk. If you have a run of very good years at the beginning, you will probably be very happy. But if you need more than 1 or 2% of your portfolio to live, a few years at the beginning of your retirement that are anything like some of the last 10 years could sink your ship before it ever leaves the harbor.

You would be wise to first develop a plan that takes your current spending needs, and your available sources of retirement income such as Social Security, Pensions, and any annuities you may own into account to see what your reliable sources of income are. Then you can determine what you will need your investment portfolio to provide you. Only then should you begin to look at what asset allocation would give you the best chance for success given the level of risk you are willing to take. In other words, you should determine your plan, your blueprint, before you determine what investments you want to buy. Don't do it the other way around. Plan the house, then build it.

I suggest you pick up a book called "7Twelve: A Diversified Portfolio with a Plan" on Amazon. It's an excellent guide on how to build a durable portfolio. Or, find an advisor who uses such an approach.

Good luck to you.

Comment   |  Flag   |  Feb 09, 2012 from Arvada, CO

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