The world of stocks can be daunting if you don’t have much experience in this arena. While stocks can be a great way to invest your money, it’s worthwhile taking your time to research what exactly you want to do with your money and what your tolerance for risk is. One thing you may have heard about is buying individual stocks e.g. Apple, but is this strategy a good idea?
Investing in individual stocks is generally not a good idea. Individual stocks have no guarantee of return of investment (ROI) and are much more akin to a gamble than investing in index funds or other safe alternatives. Individual stocks are also expensive due to transaction fees.
But why exactly are individual stocks a poor investment idea, particularly for investing beginners? Several factors play a part and I’ve taken a detailed look at each of them below.
Individual Stocks vs. Funds
Before I discuss specifics, let’s first talk about what types of investments there are available to every-day investors like you or I. Investing in the stock market basically means owning shares of ownership in a company or companies. As the value of these companies increased (measured by share price) so does the value of your investments accordingly.
In contrast, mutual funds, index funds, and exchange-traded funds (ETFs) are all examples of bundles of diversified shares of varying companies. The combination of many different companies’ shares together represents a safe, long term investment.
This is explained by the concept of diversification. If you invest in a single company, you are subject to risk as if that company has a scandal or their product is made obsolete by a competitor, your entire portfolio will suffer.
An index fund, on the other hand, can invest in hundreds or even thousands of different companies. That means if the above company ran into major issues and its share price fell, only a small proportion of your investment portfolio would be impacted.
In general, index and mutual funds are a safe investment that yields a substantial investment return over a long time. Index funds are typically passively managed by financial professionals. Active management typically correlates with a higher level of transaction fees without necessarily providing improved returns over the long-term.
On the other hand, individual stocks can be attractive for many reasons, particularly for experienced investors. You may have heard of Apple’s meteoric rise as a tech powerhouse and want to make that kind of money. It’s hard not to find the idea appealing. It is indeed true that you can make lots of money with individual stocks and many people have made their personal fortunes this way. Unfortunately, most people can’t reliably pick winning stocks that outperform the market over time.
Pros of Individual Stocks
While they’re not generally a good idea, someone may choose to buy and keep individual stocks for a variety of reasons. Below I’m going to look at some of the factors that may cause one to prefer individual stocks over mutual funds.
Fewer Administrative Fees
Mutual or other funds often require account maintenance fees or other fees for the fund’s administration and management aspects. With stocks, you only pay fees when you buy or sell. Fewer maintenance fees is an attractive pro for many people who buy stocks. Don’t be fooled though, trading individual stocks will almost certainly result in higher overall fees than investing in funds.
Stocks Are More Liquid
While funds are fairly liquid, individual stocks are even more liquid, allowing you to buy or sell at the snap of your fingers. With certain mutual funds, your sale will only go through at particular trading points and having access to your cash may be slower.
More Control Over Your Money
With funds, you don’t have direct control over your investments and are at the whim of whoever manages the fund. That can be disconcerting for many people, so they like to invest in stocks where nobody but themselves can control their money. If you’re a shrewd investor and want to put in the time to keep up with and research the market, you may find that it’s more worth your while to have a diversified portfolio consisting of only single stocks.
A related example is ethical investing. Some investors are reluctant to invest into funds which hold positions in companies they are morally opposed to. The alternative may be to purchase individual stocks of companies that you support or certain platforms offer specific ethical investing funds which don’t include companies in certain industries.
Why Individual Stocks Aren’t a Sound Investment
If you invest money, you’ll naturally want to make a profit on that investment. It sounds nice to throw a few hundred bucks at a company that’s doing well, like Amazon or Google, and make loads of cash. Unfortunately, individual stocks are often looked down on because of how volatile stock prices for individual companies are.
In order to truly make money from stocks, you’ll need information on what the company is doing at any given time. If a company is set to make a potentially lucrative product announcement, the stock may shoot up. For some, this is a good enough reason by itself to invest – but beware. Short term gains in the stock market are often just that, short term. Always do your research on the long-term health of a company you’re thinking of investing in.
A single company’s stock price can be significantly impacted by one story in the press. For me, I am not willing to allow my investments in their entirety to be determined by how the press covers that single company. For this reason, I prefer to invest in funds whereby I hold hundreds of companies.
That way, if one company’s stock price tanks, it will only have a small proportional impact on your portfolio and the negative impact on that company may be relieved by a positive impact on a competitor (that is also held by the fund).
Never Spend More Than You Can Afford To Lose
If you have your heart set on investing in stocks, a key piece of advice is to never put in more money than you can afford to lose. This means still being able to pay for day to day living expenses and any debt accrued, such as a mortgage or student loans. Investing, especially in the short term, should be viewed more along the lines of taking a trip to Vegas.
Now it’s very, very unlikely you will lose all of your money, particularly when investing in funds, but investors should be aware that the value of their investments can fall dramatically in certain periods such as recessions.
Putting money into the stock market for the long-term = investing. When well-diversified, this is very safe and unlikely to result in you losing money.
Putting stock money in the stock market for a short amount of time to make a quick buck = trading/gambling. This is high risk and people often lose money this way.
There’s always the chance of getting lucky and buying a stock at the perfect time and making a lot of money, but the odds aren’t in your favour.
Either way, the name of the game is making your investment safe for you to live your daily life and make money. If you can put in, say, a few hundred a month, great! As long as you’re able to go about your daily life without needing the money you’ve invested.
Stockholders Receive Dividends
Once quarterly, you’re entitled to receive a payment of the dividends your stock has produced. This is a way to keep shareholders happy – keep putting in money, and you will be rewarded as the company continues to grow and profit.
While dividends of a single investment may not amount to much, it’s nice to have a small stream of income trickling in while you hope your investment continues to grow.
Depending on the specific situation a company is in, it may choose to increase, decrease, or eliminate dividends entirely. Always do your research on the potential dividends you may receive from a company when considering investing your money into an individual stock.
Similarly, if you invest in ‘accumulation’ funds – any dividends paid out by the constituent companies will be automatically reinvested into more units of the fund. This is an excellent way to benefit from compounding. I wrote more on this topic here on a post about the difference between INC and ACC funds.
If you’ve made it this far, chances are you have at least a passing interest in making money off of the stock market. To do that safely and successfully, you’ll need some amount of diversification. Whether that’s in a fund or choosing stocks yourself, it’s never good to put all your money in one basket that has the potential to blow up tomorrow if the company goes under.
Generally, you can hope to realistically make around 8% of your initial investment per year in the market. This heavily depends on what precisely you invest in with different mutual and index funds have varying rates of return.
For example, if you invested £1000, you would earn £80 in investment returns per year in an average year. It’s important to note that the stock market fluctuates over time so whilst 8% a year is a good guide, some years may be much better (15%+) whilst other years you may make a loss and lose money.
While it’s an appealing fantasy to hope one of your genius stock investments explodes and makes your rich overnight, it’s best to prepare for a slow but steady race. Steadily, consistently investing in a well-diversified fund will almost certainly lead to wealth in the future.
For inexperienced investors, my opinion is that the single best strategy is investing in low-cost, passive index funds.
This has the following benefits:
- Good returns – 8-10% on average per year returns is a reasonable expectation (be aware that this may not be the case and investments can go down)
- A good risk: return ratio – as these funds are very diversified, the risk is comparatively low.
- Low fees – investing in an S&P 500 index fund using Vanguard in the UK, your total fees will be 0.21% of your investments. If you invest £1,000, that is just £2.1 per year in fees.
- Low maintenance – this strategy requires very little management. You can buy units in these funds and leave them to compound over time.
- Hold many of the largest companies in the world. Using just the S&P index fund mentioned above, you would own stock in Google, Facebook, Amazon and many other household names.
It’s a wonderful idea at any time to invest in your future, but it pays to be careful and do your research. While single stocks may not be good for you, if you diversify and never invest more than you can comfortably afford to lose, you can make a worthy lifelong investment that will serve you well for the rest of your life.
For most people, funds and in particular passive, index funds will be a better option than individual stocks. The return: risk ratio is much superior and whilst it’s less likely you will get rich quick as you sometimes can investing in a particular stock, it’s a much more reliable path to wealth over the long-term.
As always, please remember I am an Accountant, but not your Accountant. In this post (and all of my others) I share information and oftentimes give anecdotes about what has worked well for me. However, I do not know your personal financial situation and so do not offer individual financial advice. If you are unsure of a particular financial subject, please hire a qualified financial advisor to guide you.
This article has been written by Luke Girling, ACA – a qualified Accountant and personal finance enthusiast in the UK. Please visit my ‘About‘ page for more information. To verify my ACA credentials – please search for my name at the ICAEW member finder. To get in touch with questions or ideas for future posts, please comment below or contact me here.