One of the most reliable ways to improve your investment returns is to reduce the investment costs you’re paying. That’s why low-cost index funds (or ETFs, if you can buy them without a commission) are my investment vehicle of choice.
From time to time, however, people ask me whether it makes sense to put together a portfolio of individual stocks–not to beat the market, but simply to reduce costs. After all, individual stock holdings have no ongoing costs, whereas even low-cost index funds cost something.
It’s true that, depending on how much you pay for stock trades, you could reduce your costs that way. And if you’re investing in a taxable account, it could provide additional tax loss harvesting opportunities as well.
But is it Worth the Hassle?
At a very minimum, I wouldn’t be comfortable replacing my U.S. stock index fund with less than 25 holdings or so (for instance, 2 or 3 companies from each of the 10 industries/sectors listed here). And the same goes for my international stock index fund.
Surely many investors would see things differently, but setting up and tracking a 50-stock portfolio doesn’t sound fun to me.
And the amount of money you stand to save isn’t exactly astronomical. For example, if the stock portion of your portfolio was, let’s say, $600,000 and it was allocated 2/3 in Vanguard Total Stock Market and 1/3 in Vanguard Total International Stock, then the most you would stand to save in fund expenses would be $680 per year. (And that’s if you paid exactly $0 for commissions on your stock trades.)
For some investors–those with very large portfolios or those who don’t mind additional complexity–the savings may be worth it. But if (like me) you place a lot of value on simplicity, it just doesn’t make sense.
What about Replacing Your Bond Index Fund?
For two reasons, I’d argue that it’s more likely to make sense to eliminate the bond index fund in your portfolio and replace it with individual holdings.
First, Treasury bonds and CDs carry as close to zero credit risk as is possible (assuming you stay under the FDIC limit). As a result, you don’t have to diversify nearly as broadly as you would when replacing a stock index fund. A handful of Treasury bonds or CDs–one of each of, say, 5 different maturities–would be perfectly reasonable.
Second, you can often find higher yields on CDs than on Treasury bonds of similar maturity–thereby allowing you to increase your return without a meaningful increase in risk.
But again, it’s more hassle–shopping around for the best CD rates rather than just funneling money into the same index fund every month. Only you can decide whether or not that makes sense for you.