Episode 72: Should You Be Investing In Individual Stocks?

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Warren Buffett made a bet, that came to be known as Buffett’s bet, that the S&P 500 would outperform any basket of hedge funds in the next 10 years, starting 1 January 2008. If you look the final results, the S&P annualized gain was 7.1%, which is impressive considering that this challenge started during a terrible time in the market. The group of hedge funds didn’t even earn an average of 2.1% during that period of time. The S&P did pretty well, considering there were some very periods when the market did very, very poorly.  It’s weird that Buffett made this bet, because he has made his fortune by buying individual stocks. This bet was contrary to the way he invests personally.  However, in the event of his death, he directs his trustees to put 90% of the trust fund’s value in S&P 500 index funds.

This story raises the important question, in your own portfolios, should you just stay with a packaged product? Should you own only mutual funds and/or ETFs, or should I have some individual stocks, or should your portfolio be all individual stocks?

Like anything, there are pros and cons to individual stocks. You can earn a very rapid return, or you can lose everything. Individual stocks can be very low cost; they don’t have internal expenses. You have to make good decisions about when to buy and sell.

Are you a good candidate for buying individual stocks? It’s not right for everyone. You need to have a pretty large portfolio, probably at least $500,000.

If you’re thinking about buying individual stocks, what should you look for?

  1. Never commit too much money to one stock. Devin thinks you should never invest more than 25% of your total portfolio should be in individual stocks, and no more than 5% of your total portfolio should be in one individual stock.
  2. Be careful about buying a stock that you already own. Compare what you’re thinking about buying with what is already held in your mutual funds or ETFs. You can use the Morningstar website to see what’s held in your portfolio.
  3. Don’t pay attention to media that claims to give you hot stock tips – especially if they want you to pay for the information!
  4. Stay with stocks whose market capitalization is more than $2 billion. This means that the value of all the outstanding shares is more than $2 billion.
  5. Don’t fall for shares that pay high dividends. Some dividends can be good, but you have to understand how high dividend stocks are valued and what happens when the dividend changes.
  6. Use objective research to pick your stocks. Some of the companies offering research aren’t completely objective, and their recommendations are tied to some sort of relationship with the company. Find a research company that doesn’t have a broker-dealer relationship.
  7. Figure out your exit strategy before you buy the stock. If you don’t have a sales strategy, you’re going to hold on to something too long. Selling is hard, so you have to get comfortable with the fact that you likely won’t sell at the very highest possible price.

Highlights:

  • The difference between an ETF and a mutual fund
  • John’s strategy for when to sell Amazon
  • The danger of “pump and dump” schemes
  • Devin’s reasons to sell a stock

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Every few weeks, Devin and John answer reader questions during the show.  Send your questions to questions@bigpictureretirement.net.