Beware the Flaws of Trading ETFs

Choosing an individual stock poses a different set of potential risks that need to be weighed, such as picking the wrong stock in the right sector.

For example, an investor who wanted to buy a mega-cap domestic bank stock two years ago would have probably chosen between Citigroup(C Quote), Bank of America (BAC Quote) or Wells Fargo(WFC Quote). In the intervening period, Wells Fargo and Bank of America have each risen about 10%, while Citigroup has barely changed.

A more dramatic example might be picking a stock that falls because it loses market share to a competitor. For example, over the past two years, Pacific Sunwear(PSUN Quote) has fallen about 40%, while American Eagle Outfitters (AEO Quote) has risen 50%.

Picking the wrong stock is always a pitfall of investing in individual equities, just as trading quirks and fees are always pitfalls of picking ETFs.

Since the flaws inherent to these products are not going to go away, it comes back to how concerned you are by these issues and whether they outweigh the positives. The benefits to individual stocks include higher dividends (most of the time) and the potential for bigger gains. ETFs offer easier access to complicated markets and virtually no individual stock risk.

The way I look at it, I want access to what I believe will be the best tool to capture the effect, period. Most of the time, I prefer an individual stock. But for some things, such as foreign currency or the water theme, I use ETFs.

Remember: It is not about finding the best thing; it's about finding the best thing for you.