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The Rational Investor: Should I Invest in Individual Stocks?

By Teresa Conley | April 03, 2016

Our wealth advisors are often asked if investing in individual stocks is part of a wise investment strategy. We understand that question; after all, Wall Street and the financial media advocate this investment approach on a daily basis. 

Teresa Conley is a CFP, Certified Financial Planner and a 401(k) Financial Advisor with Premier Financial Group in Eureka Humboldt CountyBut unless you have a lot of money to commit for the long term, as well as the the time, experience and sophisticated knowledge necessary to make sound stock decisions -- the answer is probably not. Of course, if you're not concerned that one or more of your individual stocks may go belly-up under your watch and you have the patience to ride it out over many years, the answer might be "maybe".... but either way, investing in individual stocks means that you're taking on much more risk than you need to. 

Here's why. 

Higher Costs Impact Your Wealth Management Strategies

One reality is that investing in individual stocks can lead to higher costs. There are a number of ways this can happen.  Either you are buying individual shares in bulk and paying a per trade cost, or you may be going through a broker who is also charging you a commission for the work that she is doing.  While you may not be charged extra whether you by 10 shares or 100 of any individual stock - there will be added cost in terms of how much time it takes you to decide what stock to purchase and how many to acquire.  Remember, it is not just a stock that you need - it is the right stock at the right price.  

So, are you well-trained in the art of buying low and selling high?  You better be if you plan to build your diversified portfolio based on purchasing stocks one at a time. And will buying one stock at a time really help you build the retirement nest egg you need?  Realistically, you would need to purchase a large number of individual stocks in order to achieve significant impact on returns. For example, if you buy one share of Pepsi and the price goes up by a dollar... well, you've only made a dollar. In order to make a significant difference, you need to purchase hundreds of share per stock.

Diversification: Key to a Comprehensive Financial Plan

Teresa Conley is a CFP, Certified Financial Planner and a 401(k) Financial Advisor with Premier Financial Group in Eureka Humboldt CountyPurchasing individual stocks makes it much more difficult to achieve diversification, otherwise known as key to investment success. Diversification is more complicated than it sounds; to be truly diversified, it's essential to invest in non-correlated securities -- and that means you've got to invest across diverse asset classes, as well as in diverse securities. Do you have time to research correlation co-efficients?

For instance, if you buy stocks in BP, Chevron, Exxon, Texaco, Shell and Valero, you've got six stocks, but they're all in the same sector: Energy. If a surplus of oil hits, the stock price will decrease across the board because the stocks are correlated. That means you're not diversified. In order to be diversified by sector, industry and total number of holdings, you need to buy a lot of stocks -- and this leads to higher costs.

Record Keeping: Leave it to your Wealth Advisor

When you're buying individual stocks, you'll add significantly to your administrative work load. Not only will you have the added responsibility of keeping tabs on:

  • Company-specific risk
  • Varying cost basis
  • Proxy votes 

Over time, tracking all of these different securities can be tiresome and cumbersome and if it becomes onerous will we maintain the discipline of keeping track? 

Tax Burden and Your Comprehensive Financial Plan

Any discussion of individual stock investing must conclude with a mention of the additional tax burden they bring. Let's say you invested in a few individual stocks and your portfolio did well over a 30-year period. Now that you're in retirement, you're tired of keeping track and you'd like to sell them off. Get ready to pay capital gains!

Overall, investing in individual stocks may work for those with unlimited time, energy, and inclination to put in the hours needed to do the busy work involved with keeping tabs. But for the rational investor, skipping the unnecessary risk, lack of diversification, additional tax burden and added workload just makes sense.

 

Posted in Financial Planning

   
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