If you spend any amount of time in the personal finance community, you’ll find a huge range of opinions when it comes to investing. Some would never invest a cent in anything other than index funds, while others are investing in things like cryptocurrency and forex.
Somewhere in between, you’ll find people buying and holding individual stocks. This style of investing is probably not for the faint of heart, but is it just another gamble?
While every style of investing has its downsides, buying individual stocks has its advantages. In this article, we’ll cover what they are and whether you should consider buying individual stocks.
Stocks vs. Index Funds
Proponents of index funds usually highlight their biggest strengths: simplicity, diversification, and their ability to match an index, like the S&P (hence the name, “index” fund).
All of this also makes index funds ideal for those who work full-time and have busy lives. You can usually invest in these funds automatically, making the time commitment very minimal. And yet, they will give you a reasonable return on your investment.
However, not every publicly-traded company is a great performer, and that leads some investors in search of better returns. That is where individual stocks come in.
When you invest in an index fund, you invest in all of the companies it tracks, including the mediocre performers. On the other hand, individual stocks make it possible to avoid those poor performers.
In addition, you’re able to invest in companies that align with your own values. Index funds likely invest in at least some companies you would rather not support; individual stocks make it possible to avoid that.
What is Stock Picking?
Stock picking is just that: picking a stock in which you decide to invest. Rather than investing in a stock or bond fund that buys small pieces of dozens, hundreds, or even thousands of assets, you hand pick the stocks and/or bonds to buy.
You can invest in individual stocks more the old fashion way if you want – through a stock broker. Many people still do this, but stock brokers will of course charge a fee for their services.
Not everyone is willing to pay such fees; others simply prefer to do things more their own way. If that sounds like you, you do have options – but going it completely alone can be quite risky – especially if you are new to investing.
In the next section, we’ll cover one way you can get some guidance on picking stocks without having to work directly with a broker.
Stock Picking vs. Day Trading
Technically, day trading is a type of stock picking. Day traders typically use price trends in order to buy stocks on the rise and then sell them back, sometimes within just a few hours.
This type of trading can lead to some incredible results, but it also takes up quite a bit of time. Perhaps more importantly, it usually requires you to be trading during the day (hence the name), when the market is open.
The type of stock picking we’re mainly focusing on in this article is more of a buy-and-hold strategy. You likely won’t make quite as much as a day trader would this way, but it can still allow you to beat the market and doesn’t necessitate trading during the day.
Can You Actually Beat the Market?
At the end of the day, there’s probably little point in buying individual stocks if beating the market is impossible, right? If not, you may as well save yourself the hassle and just buy index funds.
Believe it or not, it is actually possible to beat the market.
Most investors will either tell you it’s impossible to beat the market or give you a stat about how 80-90% of financial advisors fail to do so. And that may be true, but that doesn’t mean it’s impossible.
All you really need to do is invest in a handful of strong performers and ignore the rest. That may sound overly simple, but that’s all it takes, assuming you aren’t trying to become a day trader.
Of course, the real challenge is figuring out which stocks those are. It doesn’t have to be so complicated, though. Oftentimes, the best stocks to buy are blue chip stocks like Amazon and Netflix. Recession proof stocks, like American States Water (AWR), can help with your long-term portfolio.
However, this is only part of the picture, and these things are a moving target. If you live a busy life, you may not have time to keep track of it all on your own.
Fortunately, there are services out there that can save you a lot of time. For example, Stock Advisor from The Motley Fool maintains a list of all its best stock recommendations (Note: Fool recommends buying and holding at least 15 stocks). You can read this Motley Fool review to see if their opinion is worth your time.
While it’s difficult to find real numbers as far as returns for individual investors go, The Motley Fool usually has a 4-500% ROI, which is about 4-5x the return of the S&P 500.
These numbers are bound to change in the future, as they do regularly, and not every single one of Fool’s recommendations has been a winner. However, as shown by their 4-5x return, they have done quite well overall.
Another benefit of using a service like this is how much time it saves. Because this is a buy-and-hold strategy, and all the research is done for you, the time commitment is very minimal. Depending on the brokerage service you use, you could easily spend just a few hours per month managing your portfolio.
How to Get Started
Getting started is quite easy. You can simply use a brokerage account with any major brokerage such as Fidelity, Vanguard, E*TRADE, and so on.
Alternatively, you can use an automatic investing app such as M1 Finance. I personally invest in individual stocks this way because its rebalancing makes things easy.
In addition to a brokerage account, you can also choose your own investments in an IRA you open yourself (including rollover IRAs). That typically isn’t possible if your employer funds an IRA or any other retirement account, such as a 401(k).
Employer-sponsored retirement accounts might give you some discretion as far as what you invest in, but you can usually only choose from a select group of funds. If you want access to the entire market, you typically have to open your own account.
Long story short: if you want to choose your own investments, simply open your own brokerage account or IRA at the brokerage service of your choice.
Are Individual Stocks Right For You?
The best way to answer this question is by answering two other questions: how high is your risk tolerance, and how long is your time horizon?
You should be high on the spectrum for both of these questions. In other words, you should have a relatively high risk tolerance and have a long time horizon (probably 15 years or more).
Why is that? Well, one of the things you forego by not investing in an index fund is the stability index funds provide. Indeed, although your potential returns are much higher, individual stocks can be quite volatile in the short run.
All of this means you should have a moderate-to-high risk tolerance, and be prepared to hold your individual stocks for at least 15 years.
If you are on the lower end of the spectrum for either of these criteria, it might be best to diversify a bit more.
Or, another option is to put most of your money in index funds, and invest some “fun money,” say, one-fourth of the money you invest, in individual stocks.
As you can see, it’s always possible to tailor your investing strategy to your own situation, and that’s really the beauty of it.
Because, as mentioned in the introduction, individual stocks are all about investing your money the way that works best for you.
This content is brought to you by Bob Haegele.