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Should you invest in individual stocks?

Podcast Episode Summary

If you are thinking about investing in individual company stocks, what should you consider? In today's episode we discuss:

  • Risk versus Reward: A company that does well has the potential to have its stock price go up over time, making you a lot of money. However, the opposite is also true: you can lose all your money if it goes out of business.
  • Diversification: Owning a single company makes you tied to their individual success or misfortune. Even if the sector or economy does well, you may not make money. 
  • Portfolio: You can create your own portfolio using individual stocks - but it takes quite a few (20+) to get real diversification. Or you can invest a majority of your portfolio into low-cost index funds and use a small portion in individual stocks.

What are the pros of owning individual stocks?

  • No trading fees
  • Complete control: own exactly what you want to
  • Tax management: Buy and sell for tax advantages, when you want.

What are the cons of owning individual stocks?

  • Diversification: it's harder to diversify your holdings
  • Time: it takes time to monitor your portfolio
  • fees: there are trading fees including spreads
  • Emotions: It's hard to not get carried away by emotions when evaluating your stocks

Ultimately it's up to you to decide if you want to invest in individual stocks. Just make sure you understand the risks and go in with eyes wide open!

Photo by Firmbee.com on Unsplash

Transcript

Mike: [00:00:00] Welcome to financial planning for entrepreneurs and tech professionals. I'm your host, Mike Morton chartered financial counselor and financial advisor. In today's episode, I'm chatting with Matt Robison on his New Hampshire based radio show. We discussed owning individual stocks. What are the risks and rewards? Can you create your own portfolio of individual stocks and how to think about individual investments in a larger portfolio? 

Enjoy the show.  

Matt: [00:00:29] . I'm Matt Robison I'm joined as always by Mike Morton of Morton financial advice. Mike, welcome back.

Mike: [00:00:35] Hey, Matt, always fun to be here with you.

Matt: [00:00:38] We tend to have a good time. And today we're going to talk about, at your suggestion, a topic that is fun for some people it's not fun for other people, which actually leads to, I think, some good advice for engaging with this topic. The question is, should you invest in individual stocks, Mike Morton, should people be investing in individual stocks?

Mike: [00:01:02] Maybe if it's something that you enjoy doing yeah. Today's episode, we'll break down some of the pros and cons of owning individual stocks and what to think about it's all the rage these days, with Robinhood and other apps. And it's great. I really have no problem with people, investing in individual stocks.

It's how the stock market has been run for many generations. Before, the advent of the index funds and mutual funds, which, is, has a good history of quite a few decades, but is also relatively recent. And so there's lots of pros and cons to owning individual stocks. So I tell all my clients, Matt, that it's your money.

If you want to own individual stocks, that's fantastic. Go for it. Let's just make sure that thinking about it the right way. And you understand the trade-offs there's risk reward trade-offs there's, how much of your portfolio you potentially want to put an individual stocks versus index funds or mutual funds and why you're choosing to grab individual stocks?

What's the reason behind that I think is a good way of considering how to get started or how to continue doing it.

Matt: [00:02:05] I'm a big fan of B L U F bottom line up front. It sounds like the bottom line up front on this episode is sure if it's fun for you, if it's interesting to you, then do it. But. Let's think about let's talk about some best practices, some things to bear in mind and maybe some pitfalls. If you're going to jump into this world, because as you say, there are certainly lots of great options.

So if what you want to do is not think about this and grow your wealth, protect your wealth. Think about your family's financial future. Ton of great advice out there. And there's a ton of great options. As you mentioned, index funds, mutual funds managed, passive, all kinds of things you can do, but if you're into it, if you're into it.

Okay. So individual stocks. So what should people think about? What's the starting point for thinking about? Let's say your individual stock curious, where do you start your mental journey?

Mike: [00:03:06] Yeah, just understand that in the individual stocks, you're talking about big concentration risk. Concentration risk is just going all in on one thing you could think of it as going to Vegas and deciding, to put it all on black. You're just all in on one thing. Now that's a one roll of the wheel, whereas hopefully with the investing in an individual company, they've got earnings, there's growth opportunity.

That's why you're investing in them. You think it's going to be even bigger in the future. So there's going to be ups and downs to that companies stock performance, but hopefully it's not, just a single role either doubling your money or not, but it is concentration risk. So we can think about the great stocks.

That's what we all think about, Apple or Google or Amazon or zoom and how well they've done. And ah, you think, geez, going to the moon, it's done really well, but there's lots of companies that don't. Think of companies from even 10 or 20 years ago. GE, Enron and these companies haven't done as well.

So those are the ones we don't hear about as much. We don't think about as much, but understand that when you invest in a single company you're investing in that concentrated risk of just whatever that company does, not their sector or where they're involved, but just that a single company. And the other thing to mention on this is it is a risk reward in terms of getting rich or staying wealthy.

And I always couch that as, yeah, you can go to Vegas or invest in individual companies and try to get rich or start your own company. That's a way of trying to get rich or going into real estate, and buying properties on your own. That's a way of concentrating. And that is a way of getting rich by putting your time and money and resources into a single endeavor in order to try to really do well and hit it out of the park.

Get that home run. But if you want to stay wealthy, , I encourage the opposite mindset, which is massive diversification, low risk, and just chugging along year in and year out, you don't make spectacular gains. You're just getting those walks, hitting singles, but you're doing it all over year in and out for decades.

And that's how you continue to maintain your wealth.

Matt: [00:05:06] So it sounds like the number one point to consider is just that relationship between risk reward and the fact that you take on more risk, can have more reward, but you've also got more risk. Are there other pros? Are there other advantages to think about when it comes to individual stock investing?

Mike: [00:05:29] Yeah, absolutely. So you're right. Matt risk versus reward. And there's, there's very few free lunches out there. If you want to get more reward, you have to take on more risk, which means losing money, at the, not just gaining money. Okay. So just go in with eyes wide open. That's all I'm saying.

So pros for holding individual stock, there's no fees. So that's great. When you have mutual funds or ETFs or anything of that nature, you're paying a management fee for , holding those. Diversification. So if individual stocks, there's no fees for holding it. It's great. You're complete control.

You understand exactly what your own, what you own. You can do the research, you can decide what you own and go ahead and just buy things that you want to. And so you have a lot more control and it's easier to manage your taxes. And so with individual stock holdings, you can buy and sell individual lots.

You can decide when to do that. You have much better control of your taxes. Then when you're investing in a mutual fund or index fund, Okay.

Matt: [00:06:21] got it. So what about the downsides? Let's just hit the cons while we're at it.

Mike: [00:06:27] Yeah, really quickly. The high level diversification is the obvious one. So you're invested in one company stock, or you decide to buy five different companies, individual companies. So you're invested in those and you're not getting the diversification. Now, if you look at the academic research, That's one of the only things that's a free lunch is that diversification.

When I talk about that, we're getting into statistics where, if you own the whole entire universe of stocks, you really do not have individual concentrated risk, but you still get the return of those stocks, the average return of all the stocks. Whereas when you own an individual stock, You still get the average return.

And when I say that, statistically, you get an average return for stocks. Now, obviously that individual stocks is going to do its own thing. And that's where the risk reward is, but you don't get that sort of free diversification. So that's really one of the big downsides. Another is monitoring your portfolio.

Now this could be something you really enjoy, but you've got to stay on top of your portfolio. You've got to pay attention to the markets, what's going on with that sector, or that industry. And see if you still want to stay involved. Emotionally, it's harder too, because you get attached.

If it goes down a little bit, you're like, Oh, just hold on until it's until it breaks even. So you're battling your emotions can be really a big one. And then trading fees. So I've mentioned holding is free, but if you're going to be trading more often, Then you have fees and a lot of times you might not see these.

Okay. So some of the apps now, like Robinhood and other ones, it's quote unquote free trading. So you're not paying a couple of bucks per trade, but you do pay that via the spreads and other things behind the scenes. So there is, there are costs associated with trading. And finally people have really been hit this year with understanding their taxes as well for all this trading.

So if you are getting in and out of stocks within a year, you're going to have short-term capital gains, which has taxed at your ordinary income rates. Or if you hold on, you've got, the long-term capital gains, but tax is really hit people unawares when they were doing more trading last year.

Matt: [00:08:27] You raise a really interesting point about services platforms like Robinhood, that there are fees embedded in ways that you may not realize one of the criticisms of some of the easier ways to diversify and invest is the level of fees that can be associated with those investment vehicles. Of course, there's a whole universe

of options out there. Some have higher fees, some have more active management, some are less, but it's interesting to me that you highlight that you don't necessarily shuck all of those issues by going to the world of individual stock investing and using one of these low cost platforms. So it's really incumbent on you as an individual.

If you're going to get into this. There is no free lunch here. , you need to do the homework to understand, okay, what are the fees? What are the costs? What are the risks and what are the tax implications upfront? Because at the end of the day, all those things are there. You don't just.

You don't just lose them by saying, all right, I'm skipping the world of index funds. I'm skipping the world of mutual funds. I'm going to do this myself. I'm going to run this on manual for a while as Luke Skywalker says. There's still stuff you got to pay.

Mike: [00:09:43] Yeah, that's right. And I think just going in with eyes wide open on that stuff. So if you're doing the trading, if you're more of a trader trying to get in and out of different stock positions, you're going to have a lot of time tax implications and fees on those spreads or other things now that buying and holding individual stocks typically doesn't have a trading fee.

 , this, when I say the word spread Matt, what I'm talking about is you, if you own the stock a hundred shares of Amazon, and I want to buy the stock and you want to sell it, there's a middleman. Okay. Between the two of us, I don't buy it directly from you. And so there's little fee cuts, just pennies, fractions of pennies on the dollar at a couple of stages.

And that's where a place like Robinhood was making pennies, fractions of pennies on the dollar between our buying and selling other places take less of that. Okay. So there are other brokerages that don't have as high, a spread between that. , so that's with trading.

If you're doing that, you're paying fees and tax implications, but if you just say. Mike, I want to buy, this one company, because I really believe in I'm a hold it for five or 10 years, or I think it's gonna be great. Yeah. You're not gonna really pay that much. The spread won't matter.

It's pennies. You're going to hold it for quite a few years. When you sell it a bit of long-term capital gains, you can figure out when is the best time to do that.  Understanding those rules of the game, as you say, Matt is and why you're doing this and how you're going to go about it is exactly the point.

Just, understand these various rules and implications.

Matt: [00:11:06] I'm really glad you brought up some of those best practices, like taking a long-term investing strategy. 

With a long-term vision. You think that there is a value proposition to the stock. The company has good practices, a good vision for the future. They have a good business plan. They have solid management and you're going to hold onto it. So you avoid some of that churn and some of those risks, downsides and costs and fees that you were just talking about.

, there's nothing that prevents you from achieving your own diversification by investing across an industry and picking three or four stocks from that industry.

So you're not so dependent on one player in that market segment. Or diversifying across industries. So what do you think of those high points of advice  and does it all ultimately come down to how much time and effort you're willing to spend to do all this stuff yourself?

Mike: [00:12:02] . I love that advice. I love long-term investing. Let's be honest. That's the way I think that you grow and your wealth. And whether it's an individual stock or an industry ETF or mutual fund. Now, again, you have concentrated risk with individual stocks, but you can just really do well, with those

and especially when you're going to buy and hold them. And if they're big companies, they tend to even out over time, will you make more or less than the S and P 500 index fund? I don't know. And so that's you just have to make that decision for yourself, but in terms of buying and holding, I definitely am in that camp that's a better way to go, especially with growing wealth for the future.

Now, if you talk about creating your own portfolio, that's where things get a little tricky in my opinion. If I'm going to go ahead and create a portfolio of stocks personally, I'd rather just invest in an index fund. It's just, doesn't take my time to do it. I know I'm getting, the whole world of companies for a very low cost. But if you enjoy doing that, you can definitely create your own portfolio.

I would look at having multiple companies definitely more than 20 different companies, if you're going to create your own portfolio and across different sectors. So then within each sector, you can decide, which companies you want to hold, whether it's one or two or four, within each of the sectors and create your own basket or poor portfolio, that's definitely one way of going about it.

And I wouldn't have any trouble with someone who said, yeah, I want to put in that time and effort and pick companies, I'm going to slowly buy positions over 10, 20, 30 different companies and build my own portfolio. That's great. I see a lot of people that do it the other way saying in the majority of my portfolio, I'll have index funds, especially in my 401k look, 401k has certain index funds.

Typically they might not have the world stocks available under your 401k. So you buy those index funds or target date funds, and maybe that's a good portion of your overall portfolio. 70, 80% of all your investible assets are in the 401k and the IRAs. So you just do it there. And then outside of that, either, maybe an IRA, maybe in a taxable account, you decide, Hey, I really like these companies.

I love spending time and effort researching them. And I'm going to go ahead and pick, a handful of different companies and you could do the buy and hold there. Just buy some of Apple or Amazon or, whatever company Zoom, or do you think is going to do really well and just hold it for a while.

And so that's typically how a lot of people would come in and say, look, I'm just going to play around, quote unquote, try to beat the market with some small portion of our portfolio, but not the majority.

Matt: [00:14:28] You raised it an interesting point about things being harder than people think, and that Springs to mind. When one considers the idea of picking some of these winners,  it's become trite to talk about. Like every econ 101 student hears that monkeys throwing dartboards against a big board that has all the stocks do better than professional money managers.

More of the time, because it's so easy. You alluded before, or two people getting their emotions involved. It's so easy to tell oneself a narrative about a stock, a favored company, you're you like the cut of their jib and you end up fooling yourself. What's your view on that?  In your experience?

Is it really harder than you think to pick winners consistently?

Mike: [00:15:21] Yeah, it's definitely harder than you think this is without a doubt. That's the answer. We are storytelling creatures. We love stories, right? The marketers and advertisers know this. That's what pulls at us to, make decisions and buy products  and so we always look backwards and say, ah, so obvious.

, you have the stories around it. Oh my gosh. A pandemic, of course, everyone's doing zoom, and everybody's buying from Amazon. Ah, it makes so much sense.  Matt, if I had told you a year ago, a year and a half ago, Hey is January 2020 Matt. In this year, 2020, the whole world's shutting down everything

shut down. Retail stores. Shut down, restaurants, shut down. You can't go out. Your kids are going to be home from school. Everything is shut down. If I had told you that story, what would you have done with your money? That's invested in the stock market? 

Matt: [00:16:07] I probably would have said I'm going to tell a little bit of a story myself here. This happened to me the very last time I was in a gym with a buddy of mine. He was like, hold on. I gotta break into our workout here. I got to go talk to my broker, I'm selling off and I held, and we all know what happened here.

The market went into an insane trough and then had an insane comeback. Now it turns out that my friend timed things decently well, so he got back in at a pretty good time and he didn't mess it up. But the number of people who got out and didn't time it well, vastly exceeded the number of people like

Mike: [00:16:47] That's right. And good for him. But there's two points to this story is. One, if I told you ahead of time, the whole world shutting down industries, airline and airlines are flying. Everything, you pull your money out. I would have to, man, if you tell me that for the whole year, it's shut down.

I'm getting my money out of here. There's no way this can be good. And yet the market's up 20%. The other point is that quick decline. I remember exactly those days at the bottom. That's when all the news was coming out on, like the death rates were just skyrocketing. The number of cases were skyrocketing.

Everything was just bad. If you open the papers 95% bad, like it's going to be worse tomorrow. That's when it was at the bottom. Now we all, again, we look back at the chart. Oh my gosh. It was so easy. Look at, it went down 30%. Why everything's 30% on sale? Why would you not buy. I'll tell you why it'll buy.

I remember exactly what was in the news those days, and you could not buy, it was just impossible. So looking backwards, it always looks easy, but it is particularly hard. And I'll mention one other point that makes it very hard. So that was the emotional side. That's hard, to pick these things.

The other is that there are professional money managers  spending 60 hours a week, working on trying to analyze companies, figure out who's better figure out who's going to beat the market and all this stuff. And so you at home who just like picking up the paper once a day for 10 minutes, looking through stocks and doing a little research at night, or going up against professionals that are trying to decide what the right price is for these.

And remember when you buy there's somebody selling on the other side and that's somebody selling is most likely someone's spending 60 hours a week working on these things so that doesn't make you right or wrong. It just means that's the world you're up against when you're trying to price these things.

Matt: [00:18:33] These are really important note notes of caution. And I feel like in the last few minutes, we've talked about the notes of caution. We've talked about the ways we can fool ourselves and the costs. And but I do think for balance sake, it's worth just reminding ourselves of some of the things we were saying earlier in the show, which is that if you have the time.

If you have the, if you have the resources and your eyes wide open going in, you're aware of the risks and you follow some of the best practices about trying to hold on to things for an appropriate length of time and trying to build a little bit of diversity into what you do. This is a perfectly reasonable, good, robust investment option, financial planning option for a lot of people.

Mike: [00:19:18] Absolutely. And the other thing I will say on the positive side, I see a number of portfolios, people coming in, clients coming in that had done really well. Obviously we've been in a bull market for a long time and their index funds are up appreciably as well, but I've seen people with, Amazon, Facebook, Apple, and they've done really well.

There's lots of upsides to just grabbing a stock that you believe in and owning it for a while and letting it run.

Matt: [00:19:41] I guess the, again we hit the bottom line upfront. I'll hit the bottom line again at the end, which is jump into it. If it floats your boat, it sounds like totally a thing to, to go ahead and do, just make sure to have your eyes wide open Mike Morton,  Morton Financial Advice. Thanks very much for running down this kind of fun topic.

Mike: [00:20:01] . Thanks, Matt. It's awesome. Thanks for joining us on financial planning for entrepreneurs. If you like, what you heard, please subscribe to and rate the podcast on Apple iTunes, Google play Spotify, or wherever you get your podcasts. You can connect with me on linkedin or mortonfinancialadvice.com. I'd love to get your feedback. If you have a comment or question, please email me at financialplanningpod@gmail.com. Until next time thanks for tuning in