When you think about the stock market, you might find yourself thinking about the performance of individual companies. We love hearing the stories of companies like Amazon or Apple, whose meteoric rise shows how small companies can achieve great success, seemingly overnight. That might lead you to consider a crucial investing question: Should I invest in individual stocks?
There’s no right or wrong answer to this, of course, but it’s essential to understand the risks and rewards of cherry-picking individual stocks for your portfolio. This article will explain the advantages and disadvantages of individual stocks and how they might influence your investment strategy.
What Are Individual Stocks?
If you’re new to the world of investing, it might be helpful to review a simple definition of individual stocks. A “stock” confers ownership in a company. When you buy “shares”—basically units of stock—you are purchasing a certain percentage of ownership in that company.
So when we talk about individual stocks, we’re talking about stocks that reflect ownership in one specific company. For example, if you choose to invest in Costco or IBM, each of these companies would be considered an individual stock. If this sounds confusing, that’s because we use the term “individual stocks” to distinguish between these stock purchases and a broader investment strategy such as an index fund. Index funds are mutual funds or exchange-traded funds (ETFs) composed of a diverse collection of stocks that reflect each company’s market index performance.
Why Might You Consider Purchasing Individual Stocks?
Before you jump right in, it’s necessary to take a step back and consider what you hope to achieve by purchasing individual stocks. There are generally three reasons to consider the purchase of an individual stock.
You Expect it to Grow
The most obvious reason to invest in any company is that you expect it to grow. With careful research and planning, you may discover a company you feel has real growth potential. If your research pans out, you stand to benefit from the company’s success.
You Like the Company’s Ethics
Many of today’s investors want to put their money where their heart is. Maybe you like a company’s eco-friendly initiatives or the way they support their local community. Whatever the exact reason, you might prefer investing in a company that gives back.
You Want Dividends
Some companies pay dividends to their shareholders as a way of fostering loyalty to the company. You might consider finding stocks that pay dividends at regular intervals as an additional source of investment income.
The Advantages of Buying Individual Stocks
There are some distinct advantages to purchasing individual stocks, mainly owing to the simplicity of the investment you’re making. Advantages include:
Reduced Fees
Typically, stock market investors pay a fund company or fund manager a fee for managing your stock market portfolio, usually a percentage of your overall earnings. But if you choose to invest in an individual stock, you don’t have these fees to worry about. You’ll simply pay a fee to purchase the stock and another fee to sell it.
Increased Control
When you pick your own stock, you’ll typically have greater control of what you’re invested in. You choose when to buy; you decide when to sell. That can be especially true if you’ve been doing your homework and have a greater knowledge of the company based on your research into the company’s overall performance.
Simplified Taxes
In a mutual fund, the fund determines when to take your gains and losses. You are then assigned a portion of your gains, regardless of when you bought into the fund. But if you invest in individual stocks, you have total control of what and when you buy and sell. That means you control the timing of your gains and losses, making it significantly easier to manage the taxes on your individual stocks.
The Disadvantages of Buying Individual Stocks
While individual stocks can give you a greater level of control over your investments, you must consider some significant disadvantages:
Higher Risk
It’s easy to dream of investing in the next big startup and see your money pile up overnight. But rarely does that happen, no matter how much research you put into a company. If you invest in a poorly performing company, you have a greater chance of loss than if you’d pursued a diversified portfolio.
According to a recent study, 90% of fund managers fail to achieve their financial benchmark. In other words, even trained professionals aren’t always adept at selecting high-performing stocks, which underscores the need for a diverse portfolio.
Limited Diversification
Any investment strategist will emphasize the need for diversification. Your portfolio should contain roughly 20 or more stocks to be adequately diversified, and some advisors will suggest as many as 100. You can indeed select individual stocks and build your own portfolio. Still, you may find it challenging to perform the necessary research to choose a diverse array of stocks strategically.
Greater Time Investment
Finally, monitoring any stock takes time and commitment. Fund managers do this for you, hence their fee, but it can be hard to find time to monitor your stock performance if you have a day job. Not only that, but if you see your stock pick take a steep dip, your emotions may get the better of you, prompting you to scrap your stock at an inopportune time.
When to Consider Investing in Individual Stocks
Given these risks and rewards, you may be questioning if it’s ever wise to invest in an individual stock. But the answer is actually a resounding “yes.” Individual stocks can be a great addition to an already-existing stock portfolio—and that’s the real key. If you already invested in the market through a diversified portfolio consisting of mutual funds, index funds, or ETFs, adding individual stocks can be a great addition to your existing investment strategy. Let’s consider how individual stocks might impact three different kinds of investors.
Young Investors
Young investors should generally focus on diversification. You can do that with mutual funds, ETFs, and other financial vehicles. Sometimes, the guidance of a fund manager can be of great help in strategically pursuing diversification.
In general, that means that young investors should be cautious when it comes to buying individual stocks. When you’re young, a diverse portfolio can include some high-risk stocks since you’ll have a lifetime to make adjustments to your portfolio.
If you choose to invest in individual stocks, do so cautiously—and slowly. Try to think of it as wading into a pool rather than jump into the deep end. Purchase limited quantities of shares, and never invest more than you can afford to lose.
Experienced Investors
As an experienced investor, you’ve likely already achieved a high degree of diversification in your stock portfolio. If so, you can feel a bit more liberated to invest in individual stocks, provided you’ve done your research on the company, assessing their track records, level of risk, and the company’s leadership.
Day Traders
There’s a lot of debate about the wisdom of day trading. During the 2020 pandemic, a whole new generation entered the world of investing. Day traders rely on the purchase and sale of individual stocks and can even leverage market volatility to generate a profit. However, their success stories are often negated by heartbreaking stories of tragic loss. Day trading done correctly requires considerable research and experience to navigate the market long-term. The average investor will be better off pursuing a diversified portfolio and investing over your lifetime.
Should I Invest in Individual Stocks?
Are individual stocks sound investments? The best answer to this question is: “Sometimes!” No one can predict the future, which is why diverse portfolios and investment vehicles like index funds exist to help mitigate risk.
That means that individual stocks can be fun to research and invest in, as long as you don’t put all your eggs in one basket. Focus on diversification, and then expand your horizons once you’ve gained a bit more experience. If you’re really committed to a particular company, some mutual fund managers will grant you some freedom in selecting stocks for your portfolio. They may also allow you to choose stocks from a specific financial sector (e.g., tech, healthcare, etc.).
Do your research. Consider a company’s characteristics, such as the following:
- Financial history
- Current management
- Projected innovations
- Risk level
Again, there’s no crystal ball, but you can make individual stocks a part of a balanced, diverse investment portfolio with the right mindset and careful planning.
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