Should You Buy Stocks?
However you choose to invest—retirement plan, investment account or robo-advisor—some portion of your money is bound to end up in stocks. But owning individual shares is surprisingly rare:
While 52% of Americans have money invested in the stock market, only 14% put their money in individual stocks. The vast majority of Americans, instead, hold their investments in stock-based mutual funds and exchange-traded funds (ETFs).
So should you stick with the crowd and avoid individual shares entirely? Or do they pose unique advantages that many are missing out on?
Advantages of Buying Individual Stocks
Earn Money from Growth and Dividends
There are two ways to earn money from owning stocks: growth and dividends.
With growth, you aim to buy stocks cheap and sell them after their prices rise. Buy-and-hold and value investors aim to own individual stocks for long periods of time, measured in months or years. Day traders, meanwhile, only own stocks for hours—or even just minutes. These strategies couldn’t be more different, but the goal is the same: Buy stocks when prices are low and sell them when they’re high.
In addition, stocks that pay dividends earn you money without you needing to sell any shares. When public companies are profitable, some choose to return a portion of their profits to shareholders in the form of regular dividends.
No Management Fees
Owning mutual funds and ETFs means you’re paying management fees that eat into your returns. The average expense ratio for equity mutual funds was 0.50% in 2020, though you might be able to pay substantially less, close to 0.04%, for certain index funds.
That might not sound like that much, but it can really cut into your returns. Let’s say you fully funded an individual retirement account (IRA) each year for the next 30 years and earned a 10% annual return on your balance. If you invested in mutual funds that charge the average expense ratio of 0.50%, after three decades you’d have an IRA balance of around $1 million—and you would’ve paid just over $100,000 in fees, or approximately 10% of the value of your nest egg. (A low-cost index fund would cost you just over $8,000 for the same period.)
In contrast, you pay no management fees to own individual stocks, which means more money in your pocket. This also means all the risk of investing is on your shoulders, but we’ll discuss that later on.
More Control over Your Investing
When you invest in funds, you can’t pick and choose the individual companies owned by the funds you hold. Instead, you’re stuck with whatever the fund managers decide to do to meet the fund’s governing parameters. With some mutual funds, you might not even know exactly which stocks are owned by the fund.
Investing in individual stocks gives you complete control over where your investing dollars go. Of course, that also requires you to do your own research on which stocks make the most sense for you, how much to invest in each company, and when to buy and sell your shares.
It also frees you up to invest only in companies that truly reflect your values, like you might with socially responsible investing (SRI) or environmental, society and governance (ESG)-style investing.
Disadvantages of Owning Individual Stocks
Lack of Diversification
It’s tough to get good diversification when you own individual stocks. After all, you may need between 30 and 100 different stocks for many experts to consider you appropriately diversified, and managing the regular purchase of so many different stocks can be a big headache.
Then you have to contend with the sheer expense. Unless you’re able to buy fractional shares of stocks, you’ll likely have to shell out tens of thousands just to buy one share of each company you need to diversify.
If you don’t have that much money available to invest at once, you’d have to purchase stocks more slowly—and have a lower (and riskier) amount of diversification until you saved enough money.
Greater Demands on Your Time
Mutual fund management fees might be expensive, but you’re getting a major benefit in exchange: The fund manager takes care of your money.
When you buy individual stocks, you have to manage your portfolio yourself. That means following all developments in the companies you own and adjusting the asset allocation in your portfolio as needed. Doing all of that can get very time consuming.
”Even large companies see their fortunes change over time, so investors have to keep doing their homework to check that their original investment logic continues to hold up,” says Nick Bormann, managing partner at Bormann Wealth Management. “Knowing when to sell a stock is often harder than the decision to buy it.”
You will have to spend a great deal of time monitoring the performances of the companies you choose and overall economic conditions so you can adjust your holdings accordingly. That can mean spending time every day reviewing your investments, which may be more of a commitment than you’re willing to make.
Higher Level of Volatility
When you invest in individual stocks, you’re taking on a higher level of risk. Individual stocks can have huge fluctuations in price.
For instance, Meta Inc. (FB)—the company formerly known as Facebook—experienced the biggest one-day loss in market history in February 2022. Its market capitalization dropped by $230 billion to $660 billion in one day after the firm reported its first ever decline in active users.
If you invest in individual stocks and the companies you selected perform poorly, you could lose a lot of money—or your entire investment—rather quickly. If you had owned shares of Meta, you would have seen more than 30% of your investment lost in one day.
Alternatives to Investing in Individual Stocks
If you want to invest your money in the stock market but are worried about the volatility and risk of individual stocks, you have other options:
When you invest your money in mutual funds, you are pooling your cash together with countless other investors. The mutual fund uses the combined money to purchase a portfolio of stocks, bonds or other securities. Mutual funds are professionally managed and give you instant diversification. You can invest in hundreds of companies at once by buying a share of a mutual fund.
An index fund is a type of mutual fund that is passively managed. The index fund aims to mimic the performance of a stock market index, such as the S&P 500 or the Nasdaq. It can contain all of the companies on the index, or it may comprise a representative sample.
There are index funds for different industries and sectors, including investment-grade bonds, domestic large-cap companies and emerging markets.
Like mutual funds, ETFs give you a more diversified portfolio than investing in individual stocks. The firm managing the fund buys a basket of assets with the aim to match the performance of major indexes. Shares are traded on major exchanges like stocks and they have more flexibility than mutual funds.
Should You Ever Buy Individual Shares of Stocks?
While buying individual stocks is risky, there can be some situations where it makes sense. If you already have a strong, well-diversified portfolio and can tolerate some additional risk, you can invest a portion of your money into individual stocks. This strategy can be a good idea if you feel strongly about a particular company’s potential.
“The average investor can own stocks as long as they understand the risk,” says Eric Croak, a certified financial planner (CFP) with Croak Asset Management. “For investors who enjoy researching companies and making assumptions based on different projections, individual stocks can provide strong returns with very low costs.”
However, experts typically recommend that you don’t invest large percentages of your portfolio in any one company. Whether you buy individual shares of multiple stocks or invest in mutual funds or ETFs, diversification is key.
“It’s important to remember that any investment comes with risk, and owning individual stock enhances the potential of major losses,” says Croak.
How to Buy Stocks
If you do decide to buy individual stocks, all you need to do is open an investment account, if you don’t already have one. Just make sure you have a strategy for any investment you make, and think twice before selling any of your purchases when the market dips, which it inevitably will.
“Buying individual stocks can be a fine part of a portfolio, but it requires the investor to educate themselves on the shares they buy, spend time interpreting financial statements and have a high psychological tolerance for volatility,” says Bormann. “An investor can also work with a fiduciary advisor who includes stock selection as part of their services and will help to manage a portfolio.”
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