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Why you should buy an ETF rather than picking stocks

The benefits of owning exchange-traded funds are usually presented in comparison to mutual funds, but they apply just as much to an individual investor's stock-picking.

ETFs give you the returns of a wide variety of stock and bond indexes, minus fees that are in many cases so minuscule as to be almost insignificant. Stock pickers, whether they be professional managers or individual investors, have two challenges in meeting or beating ETF returns. One, they incur fees that undercut their returns (administrative and managerial fees for funds, brokerage costs for individuals). Two, they're subject to making errors in buying and selling that undermine returns.

An ETF can also be much simpler to run – you only need four to six funds to build a well-diversified portfolio. Pick the right core funds and you'll never need to make changes that go beyond rebalancing and re-calibrating your mix of stocks and bonds as you age.

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Give ETFs some thought even if you're pretty good at stock-picking. In reporting on the Two-Minute Portfolio recently, I noted the long-term results for this ongoing stock-picking experiment have beaten the Canadian stock market index you'd likely be tracking if you bought a domestic equity fund ETF. I encouraged readers to nevertheless consider ETFs, a point that was picked up on by a reader. "You concluded by pointing out that Canadian ETFs could be a great alternative to the 2MP," he wrote. "Were you thinking of any particular ETFs to fill that alternative space, if so which ones? "

It's precisely to answer this type of question that I write the annual Globe and Mail ETF Buyers' Guide. The five installments of the 2018 edition of the guide appear on alternating Saturdays starting Feb. 3., and Canadian equity funds will be first. Meantime, here's a link to last year's guide.

If you're confident in your stock-picking abilities in the Canadian or U.S. markets, consider using ETFs to cover off the rest of the world. The international fund category is designed to give investors exposure to the world outside North America, for example. There are also ETFs that track markets in the United States and around the world.

Right about now, investment firms are sending out annual statements to clients that disclose fees paid for advice and personalized investment returns. Check your returns against the relevant indexes to see how you're doing. ETFs are a way to fix a pattern of underperformance.

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