Thanks to a reader question, I’ll share with you the approach I took to transition out of mutual funds to Exchange Traded Funds (ETFs) and dividend stocks in my investment portfolio. First up the reader question:
Chris asked My Own Advisor…
What would be your thoughts on this?
I recall a while ago you mentioned that it would be advisable to move into ETFs and dividend stocks when the portfolio value is larger to mitigate the fees associated with it. Do you know what or when that criteria could be met? I’d like to transition into ETFs or individual stocks but I am unsure how to bridge the gap.
Thanks for your question Chris, hopefully the information below will give you some insight into my situation, what I did and why I did it so you could this to help make the right decision for your own situation.
When to switch?
In my opinion, there is no absolute right answer regarding how much your investment portfolio must be worth to own Exchange Traded Funds (ETFs) or individual stocks. Your portfolio value could be $1,000, $10,000 or $100,000. However, based on what I’ve read and the practices I’ve applied in my own portfolio, I think a transition to owning ETFs and individual stocks usually makes sense when you have at least $25,000 to invest. I believe this is an appropriate value because diversification is essential in any well-constructed portfolio and to obtain some diversification, you’ll need to own at least a couple of ETFs or many individual stocks and to get that diversification, making trades will cost you money.
To sell out of your existing mutual funds or other financial products, you might be charged transaction fees to do so. If you’re fortunate not to be paying fees when selling your mutual funds, you’re likely going to be charged some fees to buy ETFs and it will definitely cost you money to buy individual stocks. As an investor, paying fees can be a portfolio killer because fees often take some time to recuperate from. To avoid paying more fees than necessary, individual discount brokerage accounts greater than $25,000 in value or household assets usually greater than $50,000 have reduced transaction fees applied.
In my case, when I switched out of mutual funds into ETFs and dividend paying stocks a few years ago, my household assets were at a point where I qualified for $10 transactions.
As a small aside, most DIY investors I know usually don’t make any ETF or stock purchases until their commission costs are about 1% or less for the transaction. That means they have saved up at least $1,000 or more to buy an ETF or stock with a $10 transaction fee.
Starting your do-it-yourself ETF portfolio can be easier than you think, and with a handful of ETFs, it can be diversified right from the start. Here are some ETFs I like because they provide diversification across many asset classes and they charge you modest and in some cases cheap money management fees once you own them.
Owning dividend paying stocks for the long-run is another excellent strategy for wealth creation but based on the diversification reasoning above, it’s hard to achieve with a small portfolio value under $25,000. Sure, you could own $1,000 of every Canadian bank, a few Canadian telecommunications companies, pipelines, utilities and energy companies as well but it will cost you a bunch of transaction fees to build that portfolio. Even with those companies, you’re still missing out. Canada only represents something like 2-4% of the entire global equity market. Even with all these Canadian stocks in your portfolio, you’re only getting a slice of the portfolio pie; you’ll need to look to the U.S. and beyond for more equity diversification.
With only a few exceptions, I waited until I had a core portfolio of at least three broad-market ETFs from Canada and the U.S. before I started investing in individual dividend paying stocks. Since those early purchases, as my portfolio value and investing knowledge grew, I took new monies saved each year and purchased individual stocks to buy and hold in various accounts. Today, I continue this approach and now own around 30 individual companies along with ETFs that are at the core of my investment portfolio. The way I see it, owning ETFs along with dividend paying stocks is a winning combination for me and my investing objectives.
You need to decide what’s right for you.
If your portfolio value is over $25,000 or your household assets are approaching $50,000, it might be time to start researching some great ETFs and/or some dividend paying stocks to own instead of your mutual funds. ETFs can be excellent products for index investors who want market-returns or those investors seeking to keep their portfolios simple and easy to maintain over time. Owning individual stocks, especially those that pay regular dividends, is also a wealth-building strategy but one must be more careful with this strategy over indexing. There are never guarantees in owning any one company no matter how long it has paid dividends.
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