Here's a Better Way for New Investors to Buy Their Favorite Stocks

Wal-Mart, PepsiCo, Disney, and other large consumer-facing stocks are typically favorites of new investors. These consumer-facing stocks are popular first investments because we're all familiar with them. And there's a relatively low-risk way for beginners to buy them.

The new stock-picker should considering consumer-facing ETFs like Consumer Staples Select Sector SPDR Fund (NYSEMKT: XLP  ) , Vanguard Consumer Staples ETF (NYSEMKT: VDC  ) , or the Consumer Discretionary Select Sector SPDR Fund  (NYSEMKT: XLY  ) , rather than buying individual stocks.

The strategy of buying these funds over individual consumer-facing stocks makes sense for new investors right now. Here's why.

Reason No. 1: Stock picking is hard
I have a simple strategy for portfolio management: I believe that individual investors should commit no more than 40% of their funds to the purchase of individual stocks. Few people have a real edge on more than 10 stocks, so you should limit your stock picks to a few businesses that you feel the best about. This is called a "focused" stock portfolio.

Your diversification should come from ETFs and index funds, not from random purchases of dozens of stocks. Simply put, stock picking is hard. It may surprise you that even mutual-fund managers typically lose to the market when costs are included. A recent report by Vanguard showed that between 1997 and 2012, only 18% of U.S. stock funds beat their benchmark index.

So don't think you'll outsmart the market every time. Match it with ETFs, and then limit stock picks to a few businesses you feel most confident in.

Reason No. 2: Funds make investing easier on your brain
The real reason so many people lose to the market is that money managers and individual investors alike tend to buy and sell at the absolute worst times, as this recent report by BlackRock illustrated. In short, we're all human, and we give into panic and euphoria; we buy high and sell low.

So let's say that you, the new investor, agree to put 60% or more of your money in index funds and ETFs. By recognizing that the biggest risk to your money is "panic selling," you can take comfort in the diversification of an ETF. If you can assure yourself that the entire market is unlikely to collapse, then you should be able to avoid panic selling, which will put you light-years ahead of the curve.

Remember that Warren Buffett always says temperament is more important to successful investing than IQ. So buy funds, hold them, and buy more when the market panics. This sounds simple, but you'll crush the market if you have the fortitude to stick with it.

Reason No. 3: These three funds offer diversification and upside
Now, let's get to why these three specific ETFs make sense over others. You can only hold an ETF with confidence during a down market if it's diversified -- and all three of these consumer-facing ETFs are. Here's a snapshot of the diversification and safety these ETFs offer.

The Consumer Staples Select Sector SPDR Fund owns consumer defensive stocks like Coca-Cola, PepsiCo, and Colgate-Palmolive. This fund also offers the buffer of a 2.6% dividend yield, and shares are up 20% this year.

Meanwhile, the Vanguard Consumer Staples ETF holds giants like Wal-Mart and Costco and has a dividend of 2.4%, while the Consumer Discretionary Select Sector SPDR Fund gives you high growers like Disney and Comcast while still providing safety, as no single firm accounts for more than 7% of its assets.

These funds offer safety because they don't have more than 10% of their eggs in any particular basket, and they all pay dividends. You should have the confidence to hold them in bad times.

Beyond diversification, these funds makes sensible options because they all have expense ratios below 0.18%, with VDC coming in lowest at 0.14%, and their managers have adopted a passive strategy. The lower fees, coupled with the absence of leverage and "market timing" by the portfolio managers, makes them safer and easier to hold during rocky times.

Finally, I like how these funds work together for a broad consumer-sector strategy. The Consumer Discretionary Select Sector SPDR Fund relies on a better economy, while the other two funds play it safe with consumer must-haves. I think holding all three gives you the security of staples in down times (think toothpaste) and the growth of discretionary items in good times (think cars) for a balanced approach.

Reason No. 4: The consumer is coming back
Aside from exposure and familiarity, there area lot of reasons to like consumer-facing ETFs. For one, consumers seem to be feeling better about the economy, largely because the state of employment is improving.

US Consumer Sentiment Chart

US Consumer Sentiment data by YCharts.

At the same point, as the chart below illustrates, consumers have saved a record amount of income while shedding debt.

US Savings Deposits - Total Chart

US Savings Deposits-Total data by YCharts.

The U.S. has an improving job market boosting consumer sentiment, all while households are increasing disposable income. This should lead to improving sales for the businesses that benefit from consumer spending going forward. So if I've already convinced you to buy and hold ETFs for safety, you should be delighted to know that these specific ETFs offer the possibility of growth due to improving consumer trends.

In summary, you'll be getting the "nerve-settling" security of diversification, along with the possibility of upside via emerging consumer trends.

Defeat your brain
It seems ridiculously obvious, by simply looking at what the stock market has done since 1920 or so, that this boring strategy is effective in the long term. The entire market will not cease to exist, so indexing or buying ETFs and "owning the market" makes sense, and you will likely beat market averages by buying more shares when stocks sell off.

Yet this strategy is not easy, because our brains are wired to hate passive investing. We're programmed to feel that "more activity" is good for our investments when, in reality, a passive investing strategy typically works better.
 
Buying the Consumer Staples Select Sector SPDR Fund, Vanguard Consumer Staples ETF, and the Consumer Discretionary Select Sector SPDR Fund, can help you win this tug-of-war with your brain. You'll get the diversification you need to avoid panic selling, along with dirt-cheap fees and positions in fun growth stocks like Disney.
 

As every savvy investor knows, Warren Buffett didn't make billions by betting on half-baked stocks. He isolated his best few ideas, bet big, and rode them to riches, hardly ever selling. You deserve the same. That's why our CEO, legendary investor Tom Gardner, has permitted us to reveal "The Motley Fool's 3 Stocks to Own Forever." These picks are free today! Just click here now to uncover the three companies we love. 


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