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Why I (Almost) Never Buy Individual Stocks

by Neal Frankle, CFP ®, The article represents the author's opinion. This post may contain affiliate links. Please read our disclosure for more info.

Do you ever kick yourself for not buying individual stocks like Google or Apple years ago? After all, had you done so, you probably would have owned Corsica by now. A day doesn’t go by when someone doesn’t ask me about this or that stock. People ask me for my opinion and if they should “take a flyer.”

Perhaps my answer is disappointing, but I almost never have any opinion on individual stocks and almost never buy them for myself or my clients. Here’s why:

a. Risk

Whenever you invest, you take risks. When you invest in equities, you take on “market risk.” What that means is that if the market does poorly, most equities will do poorly as well – your stock included. And when you buy individual stocks, the risk you take rises geometrically. Here’s why. Even if the market is doing well, your stock could still tank. All that has to happen is for the company you’ve invested in to run into any number of problems. An accounting problem. A supply line problem. A CEO problem. You name it…it might happen.

b. Research

Besides risk, you have the added headache of signing up for a ton of work. In order to do a good job investing in individual stocks, you have to spend hours and hours poring over financial reports and industry research. Do you have that kind of time? I know I don’t.

If you buy individual stocks,how do you evaluate them to know if they are a good buy or not?

c. Hunches Don’t Buy Lunches

You might be able to make money on your hunches time and time again, but I can’t. Of sure, I might make money once in a while based on a gut feeling, but over time, I won’t. And chances are, neither will you. Over the last 27 years, I’ve seen plenty of clients make money on individual stocks. But for every dollar they made, they lost two when they invested based on their hunches. And nine times out of 10, people who buy individual stocks do so without doing their homework.

d. Home Runs vs. Base Hits

With individual stocks you could hit some home runs. But when you swing for the fences, you strike out much faster. A more diversified approach ­­(explained below) makes it easier to get base hits. For most people, base hits are all they need. Why take the risk of striking out if all you need to reach your financial goals are base hits? My way of thinking is, never take undue risk.

So what do I suggest?

If you’re like most people who want to grow their money safely but don’t have the time to do the research or the stomach for all the risk, equity funds and ETFs are an excellent way to go. I’ll go on the record (again) and state that I do not believe that investors should buy and hold funds. In my experience, it makes sense to develop a method by which you “take the market’s temperature.” Invest as the market strengthens and divest as the market shows weakness. Of course, no method is perfect. Any approach you take to investing will have its pros and cons. But if your goal is to grow your money safely while taking measures to avoid catastrophic losses, this approach can be an important tool for you.

When would I buy individual stocks?

I do own a portfolio of stocks, but I don’t buy them based on my gut. I have developed a method by which I buy individual stocks that meet a very strict criteria based on data – not based on how I happen to feel that day. My system includes stop losses so that I won’t get my head handed to me when I’m wrong. And it leaves no room for my emotions or feelings. Finally, my portfolio includes 20 stocks. In effect, I have built my own mutual fund.

The bottom line is that emotions and money don’t mix. And when you buy individual stocks, the chances are much higher that you’ll make your buy and sell decisions based on your emotions. That’s a recipe for disaster.

Where do you stand on the issue of individual stocks? Do you buy them? If so, why? How has it worked out for you?

 

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Comments

  1. Spokane Al says

    July 29, 2011 at 8:54 AM

    Mr. Dodge, it sounds like you feel that there are some illegal practices occurring in the fund(s) where you invested via your 401)(k). If that is true then I suggest you contact FINRA and the SEC with the specific details of your findings and concerns.

    Reply
    • Ronald Dodge says

      July 29, 2011 at 10:50 PM

      In the case of my own investments of individual stocks, it was within a range of +/-3% of that 1% above market benchmarks. However, last year was an exception to that rule for my own individual stock investments as it was above market benchmarks by 10%, so I’m treating last year’s results as an outlier. Some may say I learned some things, but I don’t want to get ahead of myself and say that only for time to say otherwise, if time does say that otherwise. I would rather let time tell me than to speculate and be wrong. It would be nice if it was based on some strategy I did, but what if it was only luck? Hence why for the time being, I’m treating last year’s 10% above market benchmarks as an outlier.

      Reply
  2. Ronald Dodge says

    July 22, 2011 at 1:43 PM

    I do purchase individual stocks as I have no trust in mutual fund managers. Prior to me getting laid off, I had no choice but to have my money in the 401(k) plan be in mutual funds. Once my last bit of money went into the 401(k) plan after I got laid off, I did a direct roll over into a Traditional IRA. It took me some time for me to do my homework, but I did it and made investment choices based on the results of my homework.

    You see, with the mutual funds via the 401(k) plan, I found them to be moving with the market much of the time of the year, but there would be some point of time in the year when I would see a sudden drop in the value that didn’t jive with the market. As a trend with the plan vs the market, the plan lagged 2% point annually as compared to the market, so I made the assumption, this is 2% that is going to management, even though according to the prospectus, it was only suppose to be either 0.50% or 0.75% depending on the fund.

    As far as I’m concerned, they can hide their fees by dropping the NAV (aka share price) on the different funds, which then dropped your networth in the funds.

    Prior to me doing this, I had done it with my emergency fund, which my stuff doing individual stocks has trended 1% above market benchmarks as opposed to the 401(k) plan trending 2% below market benchmarks. As such, I was like, why then should I pay these so called mutual fund managers more than what they have stated in the prospectus when I can still beat the market benchmarks and the performance of their funds net of their fees?

    As for diversifications, you are absolutely right. You must diversify your funds, which I have done that my ownself with my funds.

    Reply
    • Spokane Al says

      July 22, 2011 at 2:02 PM

      Mr. Dodge, you sound like a bit of a pessimist when it comes to investing via mutual funds.

      While I am no expert, I seriously doubt that fund managers can drop NAV prices at will. I believe NAV prices are determined via a careful, fully transparent process/formula and any fund manager who manipulated those NAV prices would be guilty of securities fraud.

      I also believe that management fees fall along the same lines with full disclosure necessary before the fact, and again, if a fund manager was caught manipulating those fees, he/she would be guilty of violating securities laws.

      Anyway – good luck to you in going the individual stock investment route.

      Reply
      • Ronald Dodge says

        July 26, 2011 at 4:28 PM

        You forget about the 12b Fees route they can utilize for on going operations expenses, and that’s how they get around that.

        Reply
        • Spokane Al says

          July 26, 2011 at 5:14 PM

          12b-1 fees are fully disclosed via the prospectus. And I just avoid funds with those fees.

          Reply
          • Ronald Dodge says

            July 29, 2011 at 8:23 AM

            Then can you tell me why every single year the index funds performances via the 401(k) plan would be 2% lower than their related index? There would be one certain point of time during the year (Usually late in the year), it would drop this 2% lower than the performance of the index it is suppose to mirror, but it would never go up by that amount over and beyond the performance of the index. According to the prospectus, it is suppose to ONLY charge either 0.50% (S&P 500 Index for example) or 0.75% (International Fund for example).

            Don’t say it’s due to indexing error as if it was truely that, it would be a lot more random and it would be in both directions, not just down.

  3. Spokane Al says

    July 18, 2011 at 7:57 AM

    I agree with you on the purchase of individual stocks. Besides saving all the work necessary to track the stocks, and most people do not realize that the tough part is not in buying, but in when to sell, by owning mutual funds I will most likely acquire a position in those so-called hot stocks that better meets my allocation plan.

    Reply
    • Neal Frankle says

      July 18, 2011 at 2:03 PM

      Spokane Al, you are right on both counts. The mutual funds will acquire those stocks if appropriate and you are right that the hard part is knowing when to sell. Thanks Al.

      Reply

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Who is Neal Frankle

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I'm a CERTIFIED FINANCIAL PLANNER™ Professional with more than 25 years of experience. I feel very blessed and hope to share my personal financial experience and professional wisdom with readers of WealthPilgrim.
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While so much financial information is about preparing for retirement, what about managing your finances in your retirement years? That's exactly what we cover at Retirement Crusaders.

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