For most investors, in most situations, the most effective way to build a portfolio has been through low-cost index funds, ETFs, and mutual funds. The reasoning behind that is fairly straightforward, in that these vehicles give you broad diversification at very little cost, and they keep your attention on the thing that actually matters over the long run, which is getting the overall mix of stocks, bonds, and other assets right and then staying disciplined as the markets move around. It is an approach we have favored for years, and for the large majority of situations, it is still the right one.
There are, however, certain circumstances in which owning individual stocks and bonds directly can accomplish something that a fund cannot. These situations tend to be the exception rather than the rule, but when they apply, the distinction is meaningful. Understanding the difference can give you some insight into whether these circumstances apply to you, and whether you should be considering if the additional cost and complexity might be beneficial in your particular situation.
Why Funds are the Default
A fund, whether it happens to be an index fund, an ETF, or a mutual fund, is essentially a single pooled vehicle. You buy one position, and you get exposure to hundreds or even thousands of underlying holdings all at once, and you do it at a cost that is very hard to match in any other way. For an investor whose situation is relatively clean, meaning a tax-deferred retirement account, a fairly straightforward taxable balance, and no concentrated positions or unusual tax considerations, a fund-based portfolio is not really a compromise at all. It is the most efficient way to get where they are going, and in most cases, adding complexity on top of that just adds expense without adding much of anything in return.
That is the standard we hold the alternative to, and it is a high one. The question is never whether individual securities are interesting in some abstract sense, but rather whether owning them would actually do something measurable for a particular investor that a fund could not have done on its own.
One Decision Versus Many
In practical terms, the difference really comes down to granularity. When you own a fund, you are holding a single line item that rises and falls altogether as one piece. When you own the underlying securities directly, you are instead holding dozens or even hundreds of separate positions, and each one of those can be looked at and managed on its own.
For the majority of investors, that degree of control simply is not necessary, but for a smaller group of people, it turns out to be exactly what their situation calls for. The circumstances where that tends to be the case are the ones described below.
Large, highly taxable accounts. When you own the securities directly, tax-loss harvesting can be done at the level of each individual position rather than the portfolio as a whole. Even in a year when the market is up overall, some of the individual holdings will still decline, and those losses can be captured and used to offset gains elsewhere. A single fund, by contrast, only produces a harvestable loss when the entire fund is down, so holding the underlying names tends to create more frequent and more precise opportunities, and over time, that can meaningfully improve after-tax results.
Concentrated or restricted stock. When a large share of someone’s net worth sits in a single stock, whether that was built up through a company, through equity compensation, or through an inheritance, the rest of the portfolio can be constructed deliberately to diversify around that position instead of ignoring it. It also makes it possible to put together a thoughtful, tax-aware plan for reducing the concentration gradually over time, on a timeline that makes sense rather than selling all at once.
A business sale or other liquidity event. A liquidity event tends to introduce several things at the same time, including a large taxable gain, a significant amount of money that suddenly needs to be reinvested, and a shift from holding one concentrated asset to holding a diversified portfolio. When the securities are managed directly, the timing of gains and losses, the way the proceeds get deployed, and the estate and tax planning that surrounds the whole event can all be coordinated together as one strategy rather than handled piece by piece.
Trust, estate, and multi-generational complexity. Families with trusts, with multiple entities, or with estate-tax sensitivity often need decisions made at the level of the individual security, including managing cost basis for gifting, coordinating holdings across a number of different accounts, and working within the specific constraints that apply to each entity. That kind of customization simply is not something a single pooled fund can be made to do.
Significant holdings managed elsewhere. When an investor has meaningful assets sitting outside the portfolio, such as legacy employer stock, real estate exposure, or an account held somewhere else, owning individual securities allows the managed portfolio to be built around those holdings, so that the overall picture ends up diversified and coordinated rather than accidentally overlapping in ways no one intended.
Weighing the Trade-off
A portfolio made up of individual securities does cost more to manage than a fund-based one, and that cost is really the central consideration here rather than an afterthought. The question worth asking is whether the benefit, meaning the additional tax-loss harvesting, the strategy that can be built around a concentrated position, or the kind of customization that a complicated estate requires, is likely to outweigh that added expense for a particular investor. In situations where the circumstances above are clearly present it frequently does, and in situations where they are not present it usually does not, which means that for most people, the simpler and lower-cost approach ends up being the better one.
Matching the Approach to the Situation
The goal here is not really to choose a side between funds and individual securities, because both of them are simply tools, and the more useful exercise is figuring out which tool fits a given situation. For the large majority of investors, low-cost index funds, ETFs, and mutual funds are going to remain the most effective foundation, and when something is already working, there is usually no good reason to complicate it. For the smaller number of investors whose circumstances genuinely call for it, whether that happens to be a meaningful amount of taxable assets, a concentrated position, the sale of a business, or a complicated estate, owning individual securities can earn its place in the portfolio.
The harder and more valuable part is being honest about which of those descriptions actually fits your own situation, and that is where our team is here to help. We spend a good deal of our time guiding clients through exactly these kinds of complex implementation questions, and together with our partners at RBC Rochdale, we are now able to build and manage portfolios on the individual stock and bond side as well, for the situations that genuinely call for it. If you would like to learn more about our individual stock and bond solutions and whether they might be a fit for your circumstances, please feel free to reach out, and we would be glad to talk it through with you.
Kirsten Halpin, CFA®, CAIA®, FRM®
Director of Investments
This material reflects the author’s opinion, is not intended to be investment, tax, or legal advice, and is provided for illustrative purposes only. Alaska Wealth Advisors is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about Alaska Wealth Advisors’ investment advisory services can be found in its Form ADV Part 2 and/or Form CRS, which is available upon request.
Tax laws are subject to change. Please contact Alaska Wealth Advisors if there have been any changes to your financial situation or investment goals, or if you would like to add or modify any reasonable restrictions to your investment portfolio.
