Investing in individual companies vs funds – what’s better?

In July 2019, Sharesies started allowing their users to invest in individual companies listed on the NZX, New Zealand’s sharemarket. Sharesies have already done a spectacular job in making funds more accessible to Kiwis, and now this has generated increased interest in investing in individual companies. So what are the pros and cons of investing in individual companies compared to investing in funds?

For this comparison, we’ll be looking at investing in the fund “NZ Top 50 ETF” (a fund invested in the 50 largest companies on the NZ sharemarket), versus investing in individual companies listed on the NZX.

Update (17 November 2019) – added more pros and cons to the article

1. Reasons to invest in individual companies

You have much more control

When you invest in a fund like the NZ Top 50 ETF, you have no control over what companies are contained within that fund. If you hate a company within that fund, too bad – you’re stuck with it. It’s like getting a box of Cadbury Favourites, and having to eat the Cherry Ripes that you don’t like πŸ™ .

When you invest in individual companies, you can choose exactly which companies to invest in, based on your preferences and investing objectives. It’s like having a box of Favourites that you get to choose exactly which chocolates are in the box. No Cherry Ripe for me thanks!

Now for some real examples where more control may come in handy:

  • You might want a safer, lower risk portfolio, in which case you might choose to invest in relatively stable companies like Genesis Energy and Spark.
  • You might want a higher risk portfolio, with potential for higher returns. In which case you might choose companies like a2 Milk and Vista Group.
  • You may like a particular industry sector. E.g. you might think the retirement village sector may perform really well because of our ageing population, so you want to invest in companies like Summerset and Oceania Healthcare.
  • You may dislike a particular company or industry sector. E.g. you might think the retail sector will perform badly, so you build a portfolio that avoids companies like Kathmandu and The Warehouse. Or you may dislike a company for ethical reasons e.g. SkyCity for being involved in gambling.
  • You may simply just love a particular company. One of my very first investments was in Air New Zealand, just because I loved the airline and aviation in general. Although I admit this isn’t the smartest strategy for choosing what to invest in!

Potential for greater returns

When investing in a fund like the NZ Top 50 ETF, the returns for that fund will be the average return of all the companies inside that fund. While there may be spectacular performing companies in a fund, there is always going to be poor performing companies which drags down the fund’s overall performance. For example, the NZ Top 50 has made a return of 25% so far in 2019. While Fisher & Paykel Healthcare has improved the performance of the NZ Top 50 (having increased by 60% over the year), companies like Sky TV have dragged its performance down (having decreased by 53%).

So by investing in individual companies, your potential returns are greater as they are not held back by poor performing companies. However, firstly, it is incredibly difficult to pick companies that will outperform the average. And secondly, it is even more difficult to outperform the average consistently over the long term. Therefore when investing in individual companies, outperforming funds is only a small possibility, rather than a guarantee.


It can be more rewarding

When you’re invested in an individual company, you get to go along for the ride and follow that company’s achievements, challenges, and plans for the future. It’s like quietly cheering on your favourite sports team. Individual companies feel more tangible (e.g. you can see and touch Air New Zealand and their planes), while with funds, it can feel like you’re investing in something that’s a bit faceless.

In addition, you get to attend shareholder meetings and events (free food!), vote on important company issues, and participate when your company is raising more money to fund future growth. Not everyone will be interested in all of these things, but I can say that I’ve learnt way more from investing in individual companies than from investing in funds.

2. Reasons to invest in funds

Instant diversification

“Don’t put all your eggs in one basket” is a saying we’ve all heard. In the investing world, you probably shouldn’t invest all your money into one individual company – because if that company goes bust, you’ll lose all your money. Therefore you should invest in many companies in order to diversify your portfolio. It’s also best to invest in companies from various different industries, in case a particular industry performs poorly. For example, a portfolio containing Contact Energy, Genesis Energy, Trustpower, Mercury, and Meridian Energy isn’t a well diversified one!

Funds make diversifying your investment portfolio significantly easier as they already contain a collection of many companies (maybe even thousands). If you invest in the NZ Top 50 fund, you get instant diversification, as your investment is automatically spread across 50 companies, in a variety of industry sectors.


You don’t have to do much research

If you’re keen on investing in individual companies, how do you choose which company to invest in? You could always pick one you like the sound of (Air New Zealand in my case), but good investors should always do some research into a company before investing in it. This might include:

  • Reading a company’s annual reports and investor presentations to understand their achievements, challenges, and strategies for the future.
  • Thinking about the opportunities the company has to expand and grow.
  • Thinking about the risks the company may face e.g. more competition or lessening demand from customers.
  • Looking at the finances of the company e.g. ensuring they’re not overwhelmed with debt and have strong cashflows
  • Looking at the share price and measures like the P/E ratio to ensure you’re not paying too much for your shares in the company

And the research doesn’t just end once you’ve picked a good company to invest in. As a shareholder of a company, you may occasionally receive opportunities to buy more shares in the company, or the chance to vote on important company issues – both of which may require a bit of research to inform your decision.

With funds you don’t have to worry about picking companies, researching each one, and keeping up to date with the companies you end up investing in – you just have to decide on the best fund(s) to invest in to meet your financial objectives, then let the fund manager take care of the rest. That’s much easier!


It’s a hassle to invest in companies outside of NZ

So far in this article I’ve only talked about investing in NZ based companies and funds. What if you wanted to diversify your investment portfolio into international markets like Australia or the United States? – Which is a good idea since NZ is so small, both geographically, and in the size of our financial markets.

While Sharesies makes it easy to invest in NZ companies, it is a bit of a hassle to invest in overseas companies. Services like Hatch make it easier to invest in US companies, but you still have to covert your money from NZD to USD, and pay a brokerage fee of at least $3 USD each time you buy or sell shares. It also takes extra effort to deal with your tax obligations on overseas investments.

However, there are plenty of funds that invest in overseas companies, such as the Smartshares Total World ETF, which invests in over 8,000 companies from all around the world. Investing in these funds give you exposure to foreign companies without the hassle of currency exchange, brokerage fees, and tax.

3. Why not both?

There’s nothing stopping you from investing in both individual companies and funds. Here’s a couple of examples:

  • Tilt your portfolio – you might invest in the NZ Top 50 fund to get instant diversification in the NZ market, but still really like a particular company or industry sector. For example, if you’re a fan of the retirement village sector, you could also invest in a company like Summerset in order to “tilt” your portfolio to gain more exposure to that sector, than you would by just investing in the NZ Top 50 fund alone. It’s like getting that box of Cadbury Favourites, and getting to add more of your favourite chocolate (like the Picnics πŸ™‚ ).
  • Core-Satellite Strategy – this involves investing primarily in funds (the core of your portfolio), while investing a little bit in individual companies (the satellite). It gives you the best of both worlds, without exposing you to too much risk since the core of your portfolio is invested in diversified funds.

What should you do?

Your strategy will depend on your personal preferences and investment goals, but I think investing in funds is the way to go for most people. It is really challenging to research and choose individual companies to make up a diversified share portfolio, so having a fund manager do all this for you makes investing a whole lot easier. There is no need to worry about whether you picked the right company, and no need to keep up with a company’s news. But even if investing in individual companies is not right for you, it’s still fantastic that platforms like Sharesies is opening up more options for Kiwis to grow their wealth.

Personally, I invest in individual companies when it comes to New Zealand companies, and invest in funds when it comes to international markets. This is because I want control over what local companies and industry sectors I’m invested in, but at the same time I don’t want the difficulty of researching companies in overseas markets that I’m less familiar with, and the hassle of converting currency in order to make overseas investments.

If you’re keen to start building your investment portfolio with Sharesies, you can sign up with this link, and I’ll get $5 in my own Sharesies account. A great way to show your support for this site!

What’s next? Compare buying shares on Sharesies with buying them through a traditional broker.

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Disclaimer

The content of this article is based on my personal opinion and should not be considered financial advice. The information should never be used without first assessing your own personal and financial situation, and conducting your own research. You may wish to consult with an authorised financial adviser before making any investment decisions.