The shift towards ETFs and away from individual stocks is apparently now complete.  Two recent articles highlight the lengths to which investors will go to avoid individual stocks in favor of ETFs.  The first makes the case for software ETFs based on recent Microsoft (MSFT) earnings.  The second makes the case for heath care ETFs based on Johnson & Johnson (JNJ) being undervalued.

Microsoft and Johnson & Johnson are currently third and sixth in terms of market capitalization in the S&P 500.  If your aversion to individual stocks is so high you cannot muster an investment in either of these companies you probably shouldn’t be investing in the respective sector ETFs either.

We have no idea whether Microsoft* or Johnson & Johnson** will outperform the market or their respective sectors.  However if your thesis is that these companies are undervalued then the most logical step is to invest in them directly.  The perceived diversification benefits of sector ETFs will likely dilute the returns to your investment thesis.

If the issue is risk, then there are ways to target individual stocks while limiting your downside risk.  The entire options complex exists to provide investors with a way to define your downside risk in any particular optionable security.

This is not a knock on ETFs in general.  While there are plenty of issues with ETFs, the introduction of sector ETFs has been a boon to investors of all stripes.  Indeed the ETF industry continues to introduce new products that investors are happy to embrace.  However it does not necessarily follow that every investment thesis is best served by an ETF.

Risk exists whenever you participate in the equity markets.  ETFs don’t eliminate risk.  They only spread it around.  The onset of the ‘golden age of stock picking‘ may still be here, but that does not mean that individual stocks should be avoided at all costs.

*See this Grey Owl Capital Management investor letter (via Real Clear Markets) for the fundamental case for Microsoft.

**No position in either $MSFT or $JNJ.

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