Why? Simple: You are not Superman. Nobody is. And you aren’t going to get any real market advantage over the professional investors by watching CNBC Squawk Box and Cramer. By the time information gets on TV, the smart traders have already acted on the information, and you’re going to get what’s left over.
You’re going to make your share of investing mistakes – and if you are very, very good, you may well be able to match the returns of the S&P 500 over the course of your investing lifetime.
If you do, bear in mind – even if all you do is break even with the S&P 500, after all your expenses, you are already outperforming the substantial majority of all professional stock mutual fund managers. These with sophisticated computer programs, discounted institutional broker pricing, and full-time staffs of very smart and highly-trained analysts at their disposal.
The problem with the middle-class investor and buying individual stocks is this: Few investors have a portfolio large enough to efficiently buy enough different stocks to adequately diversify their portfolios against the unpredictable and uncontrollable. Buying blocks of under 100 shares (what brokers call “odd lots” is costly, in terms of commissions, and you get tagged with invisible costs, such as bid-ask spreads, that you will never see, but which conspire against your returns.
It’s only when you get to portfolios of $1 million plus, or close to it, that we really have a lot to work with, when it comes to trying to build a single-stock portfolio from scratch.
Does that mean individual stocks have no place in your portfolio? Certainly not! Here’s where individual stock ownership can really play a beneficial role in your portfolio:
- Your employer provides a 401(k) match, profit sharing, ESOP or other equity incentive. If it’s free money, take it!
- You are tax sensitive and want to be able to use ‘tax harvesting’ strategies to control your capital gains exposure. Specificially, if you have several different stocks, and you need cash from your portfolio or you need to make some changes, you can sell some stocks at a loss to offset any taxable profits. This is going to be more important if the capital gains taxes increase from 15 to 20 percent, as they are scheduled to do in 2013.
- You have maxed out your IRA, 401(k) and other tax-deferred or tax-free savings and investment contributions.
- You are participating in a well-designed and constructed DRIP, or Dividend Reinvestment Program, which helps you avoid some of the costs associated with buying individual stocks.
- You want to own stock in a company or industry that tends to do well when your company or industry does poorly. For example, if you worked for a buggy whip company in 1905, it would have been wise to hedge your bets by owning some stock in Ford.
- You have some unique knowledge of a company or industry – legally obtained, of course – that gives you an advantage even over professional Wall Street analysts and sophisticated, professional investors.
- You love the process of investing and you truly enjoy the hunt.
- You can afford to lose 50 percent or more on your entire stock portfolio, and you can afford to watch any one of your investments go completely bust overnight, and not break a sweat.
Do you fall in one or more of the above categories? Then let’s talk about forming a coherent risk management and investment strategy that balances the downside risk against your objectives and your overall portfolio and situation.
Are you in the “none-of-the-above” category? Then let’s stick to funds and index funds, and balance that against your cash savings picture, your insurance plan and your various sources of income – be they from labor, small businesses, passive activities, real estate, or anything else.