Many stockbrokers recommend that clients invest in mutual funds, ETFs, or other vehicles that contain a range of stocks or other assets. But some investors have their sights set on a particular company. Is there value to investing in individual stocks, or is it better to stick to the tried-and-true method of investing in a diversified mutual fund?
To make an informed decision, you should know the risks and rewards of buying single stocks and understand how to integrate this method into a broader investment strategy.
Advantages of Buying Single Stocks
Investing in individual stocks offers many advantages. Here are some of the reasons you might consider researching and selecting stocks outside of a combined fund.
When you invest in a mutual fund or index fund, you’re limited to the stocks that the fund manager has selected for the account. Sure, you can investigate each company to learn more, but many mutual funds contain stocks from well over 100 different companies.
By selecting stocks on your own, you’ll have greater control over where you invest. You’ll also better understand what you’re investing in, which is perfect for those who want to support companies whose values align with their own.
You’ll also decide when to realize gains and losses instead of relying on the fund manager’s discretion.
Potential for Growth
Every investor dreams of making it big. Buying individual stocks allows you to invest in that hot new startup you’ve been hearing about. After all, if you’d invested $10,000 in Apple (AAPL) stock in 2003, you’d be sitting on $7.51 million today.
Day traders purchase individual stocks regularly, sometimes holding these positions for only a few hours, or even minutes. But even long-term investors can purchase growth stocks that increase in value, providing reliable gains over time.
When you invest in a mutual fund, you may have to pay a management fee for someone to actively manage the fund’s contents. These fees are generally low — 0.04% to 0.5% — but they can still take a bite out of your total profit.
By contrast, investing in individual stocks requires no management fees. You’ll only pay a fee when you purchase the stock, then again when you sell it. As a result, you’ll retain a larger percentage of your gains.
Easier to Manage Your Tax Liability
Buying individual stocks will not only give you greater control over your portfolio but will also give you greater control over your tax liability.
In a mutual fund, the fund itself determines when you receive the gains and losses. Even if you just invested into the fund at the end of the year, you could still be liable for your portion of any gains on your annual income taxes. But by investing in individual stocks, you’ll control the timing of your gains, allowing you to personally manage your tax liability.
Disadvantages of Buying Single Stocks
Despite these benefits, there are some drawbacks to investing in individual stocks. Here are some reasons you might proceed with caution.
Stock funds offer built-in diversification, which means that if one sector underperforms, the other stocks in the portfolio will likely mitigate the loss. But it’s hard to obtain that same level of diversification by purchasing individual stocks.
Consider what happened to Meta (formerly known as Facebook) in 2022. The company’s market capitalization fell by $230 billion in a single day — the greatest single-day loss for any U.S. company in history.
Investing in any individual company carries the risk that the stock you select might not perform as expected and cause you to take a significant loss.
Remember that a mutual fund gets its name from the way fund managers pool resources from multiple investors. This allows you to purchase collections of assets at reasonable prices. But the same can’t always be said when selecting individual stocks.
Unless you purchase fractional shares, you could be looking at high prices for a single stock. Sure, buying one or two stocks might not seem like much, but in order to achieve diversification and mitigate risk, you’ll need to make multiple investments, which could quickly deplete your investing budget.
Requires More Management
Many mutual funds are actively managed, which means that the fund manager or your account broker takes a direct role in maximizing your returns. And the fund itself is populated by a balanced assortment of well-researched stocks.
But when buying individual stocks, you’re basically on your own. You’ll have to take a direct role in researching each stock you buy, making sure to select stocks from multiple sectors to achieve balance and diversification.
And once you complete your purchase, you’ll have to invest time in monitoring your investments and making adjustments based on each company’s performance. That can be a major time commitment for casual investors.
Alternatives to Investing in Individual Stocks
Because of the risks associated with individual stocks, many investors opt for some type of fund. These are called “basket investments” since you’ll be investing in a ready-made collection of assets, which also gives you built-in diversification right from the start. Here are the most common types of funds.
Mutual funds are among the more popular types of stock funds. When you invest in a mutual fund, you’re investing in pieces of 100 or more underlying securities. As a result, you’ll experience built-in diversification and protection from market volatility.
Some mutual funds are built around certain sectors (such as tech, healthcare, or energy), though many are broadly diversified.
Index funds function very much like mutual funds. The key difference is that these funds are designed to track a particular market index, such as the NASDAQ or S&P 500. They may not offer the chance for huge gains, but by tracking an index, you’re more likely to see steady, slow growth.
Exchange-Traded Funds (ETFs)
Exchange-traded funds also operate similarly to mutual funds, but ETFs have greater liquidity since they can be traded directly on the stock market. They also have lower capital gains taxes compared to mutual funds. And since they don’t come with investment minimums, they can be ideal choices for beginning investors.
A Hybrid Approach
Of course, you don’t have to face a stark choice between funds and individual securities. If you have a solid foundation built on mutual funds or ETFs, you’ve already shielded yourself from most of the major market risks. That gives you more freedom to explore investing in individual stocks as part of a larger investing strategy.
How to Buy Individual Stocks
If you opt to invest in individual stocks, you can do so through most brokerage accounts, including popular online investment accounts.
Just remember that when you purchase individual stocks, you’re essentially on your own. You’ll need to research each selection with the utmost care and monitor your investment to track its performance over time.
That’s why it helps to have the right stock research tools on your side. These tools help you stay on top of where your portfolio is headed and make the most well-informed decisions about your investment.
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