Do you ever get the feeling that your stock portfolio has been going nowhere fast? Even though stocks are up around 70% from their March 2009 lows, millions of investors still have less than what they started with. 

Let’s analyze how the stock replacement strategy can help you.

Market Size

What do Best Buy (NYSE: BBY), McDonald’s (NYSE: MCD) and Starbucks (NASDAQ:  SBUX) all have in common? They are recognized consumer brands and they are all large company stocks. Which ones do you buy?

The stock replacement strategy solves the investor’s dilemma of which stocks to buy. Since stocks come in three general sizes (large cap, mid cap and small cap) simply owning a corresponding ETF to match your desired market size accomplishes your mission.

Large-cap ETFs like the iShares Russell 1000 (NYSE: IWB) or the Vanguard Large Cap ETF (NYSE: VV) can be substituted in the place of stocks like Best Buy, McDonald’s and Starbucks. For mid and smaller sized stocks, substitutes like the SPDR S&P MidCap 400 ETF (NYSE: MDY) and the Vanguard Small Cap ETF (NYSE: VB) can help you to execute your stock replacement strategy.

Virtually any publicly traded stock can easily be substituted with an ETF that matches its market size.

Growth and Value

Another defining characteristic of stocks is whether they are growth or value oriented companies. Generally, stocks with no dividends, faster growing earnings and higher P/E ratios are considered growth stocks. Conversely, stocks with higher dividends, steady earnings and lower P/E ratios are generally categorized as value stocks.

What’s better? Growth or value stocks? It’s really a matter of preference, but here too, ETFs can be substituted in the place of individual stocks.

Instead of banking your fortunes on a single growth stock like Amazon.com (Nasdaq: AMZN), growth ETFs like the iShares Russell 1000 Growth ETF (NYSE: IWF) or the Vanguard Large Growth ETF (NYSE: VUG) allow you to bank on a group of growth stocks with similar growth characteristics to Amazon.com.

Industry Sector

Let’s suppose you’re bullish on the future prospects of the energy sector. You don’t need to buy Chevron (NYSE: CVX),  Exxon Mobil (NYSE: XOM) or some other energy stock to participate. The stock replacement strategy allows you to invest in energy-related ETFs that own a group of energy stocks. Furthermore, some of these very energy ETFs may even own CVX or XOM!

Corresponding substitutes for CVX or XOM would be the Sector Energy ETF (NYSE: XLE) or the SPDR S&P Oil & Gas ETF (NYSE: XOP).

The stock replacement strategy works well for just about any stock and its matching industry sector.

Benefits of Replacing Stocks with ETFs 

The most obvious benefit of the stock replacement strategy is portfolio diversification. In other words, you reduce your financial risk to individual companies. Indeed, this is one of the most overlooked secrets of successful investing. It isn’t so much about picking the right stocks, as it is avoiding disasters. And even stocks that are doing well are susceptible to unexpected blowups that not even the best or most intensive stock research can prepare you for. (See Goldman Sachs (NYSE: GS), BP (NYSE: BP) and Toyota Motors (NYSE: TM) ).

Instead of trying to build an investment portfolio one brick at a time, the stock replacement strategy saves you time. How long would it take you to build a diversified portfolio of 500 to 1,000 stocks? Before you could finish, the trading costs would likely bankrupt you.

Lastly, the performance benefits of the stock replacement strategy are unparalleled.

Investment study after investment study continues to prove the vast majority of professionally constructed stock portfolios (active mutual funds) consistently underperform corresponding index funds or index ETFs. So by owning a portfolio built upon index ETFs you can avoid all of that chronic underperformance. You also avoid the higher investment costs associated with those losing strategies.

In summary, the stock replacement strategy can be a win-win for you.  

This article was written by Ron DeLegge, Editor of  ETFguide.com. ETFguide is the information leader on exchange-traded funds because of its vendor-neutral approach and its progressive reporting style. Unique features include an ETF bookstore, a monthly e-mail newsletter and subscription-based ETF portfolios.