Should You Buy Individual Stocks or Stick to Mutual Funds? (2024)

Here are some rules if you're feeling lucky

Should You Buy Individual Stocks or Stick to Mutual Funds? (1)

Should You Buy Individual Stocks or Stick to Mutual Funds? (2)

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By

Allan Roth,

En español

Published December 11, 2020

I own over 10,000 individual stocks with just one total U.S. stock index fund and one total international stock index fund. That's the core of my stock portfolio, and both have had a good year so far.

As happy as I am with my funds, they still don't exercise the piece of my brain that wants to have a little fun picking individual stocks. I'm of the opinion that it's fine to have a little fun with investing and it's OK to pick some stocks, as long as you follow some rules.

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Thrills and chills

It would certainly be fun to imagine owning only the top 10 performers in the Standard and Poor's 500 stock index this year through Dec. 1, 2020. Here they are, according to S&P Capital IQ.

S&P 500 Index 10 Top Performers 1/1/2000 - 12/1/2020

Company name — (Ticker) — % change

Etsy, Inc. (NasdaqGS:ETSY) 249.1

NVIDIA Corporation (NasdaqGS:NVDA) 127.9

L Brands, Inc. (NYSE:LB) 117.3

Advanced Micro Devices, Inc. — (NasdaqGS:AMD) 102.0

PayPal Holdings, Inc. (NasdaqGS:PYPL) 100.2

FedEx Corporation (NYSE:FDX )92.7

ServiceNow, Inc. (NYSE:NOW) 91.1

Albemarle Corporation (NYSE:ALB) 88.7

West Pharmaceutical Services, Inc. (NYSE:WST)81.5

Freeport-McMoRan Inc. (NYSE:FCX) 80.9

(data source: S&P Capital IQ Equity Screening Report)

Even better would be to own a few of the top performers not in the S&P 500 — such as Tesla (TSLA), up 598.9 percent, and vaccine maker Moderna (MRNA), up 620.9 percent. Tesla, by the way, is the sixth-most-valuable U.S. stock. The company's stock will be admitted to the S&P 500 on Dec. 21. Of course, at the start of the year, Corona was associated more with a beer than a pandemic, and Zoom was something you did with your camera.

In addition to much else, 2020 was certainly the poster year for unpredictability. And unpredictability can make picking stocks pretty thrilling — which, admittedly, is a feeling to which I'm not immune. Beneath my dull exterior of an index investor beats the heart of the Gambler. Even I get the occasional urge to buy that risky stock and get those spectacular returns, and sometimes I just can't resist acting on my thrill-seeking urges.

That's why I carve out a small piece of my portfolio for, perhaps, the only fun I have in investing. I call it my gambling portfolio.

My rules

Now, everybody should have a personal system to outsmart the market. My own belief is that buying one of these stocks after a spectacular gain is following the herd and doesn't end well. Though I don't tell people what they should buy, I do give them rules.

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My system is buying stocks that have fallen from grace and that I think have about a 50-50 chance of going bankrupt.

Companies shunned by Wall Street can often end up performing not as badly as expected, and the stock price rises if the company exceeds the Street's low expectations. It's very risky, I'll admit, but I think it's better than being part of the herd following TV gurus or buying a stock after a spectacular return.

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I'm always happy to talk about my winners, such as Priceline (now Booking), IBM and, more recently, GE (so far, anyway), though I conveniently block out my purchases of United Airlines, Delta Airlines, Eastman Kodak and others that didn't make it or are looking rather bleak.

How has it worked? In my emotional mind, the Gambler convinces me that I have kicked market booty with the returns I've received. I don't really care what my logical mind says because, you know, this is supposed to be fun. I could easily go back and evaluate my return versus the market, but why do that? I prefer to keep my parade unrained on.

What does this mean to the gambler in you?

My emotional brain is in the driver's seat for my gambling portfolio. This is invested in a strategy that I think will win by picking ultra-risky individual stocks that Wall Street doesn't want.

I call my total portfolio a core-and-casino approach. The core part is in the logical, dull, own-the-whole-market index funds. The casino part consists of the risky-business stocks I pick from the emotional side of my brain, or the Gambler approach. Viva Las Vegas.

Mark Twain once remarked that the rules that got him to age 70 would kill anyone else. These are the rules that work for me. They may be too risky for you, or even not risky enough. But the rule you should always remember is rule number one: Gambling is gambling, and whether it's investing or blackjack, I bet only what I can afford to lose — typically, less than 5 percent of my portfolio.

Allan Roth is the founder ofWealth Logic, an hourly-based financial planning firm in Colorado Springs, Colorado. He has taught investing and finance at universities and written forMoneymagazine,theWall Street Journaland others. His contributions aren't meant to convey specific investment advice.

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Allan Roth is a practicing financial planner who has taught finance and behavioral finance at three universities and has written for national publications including'The Wall Street Journal.' Despite his many credentials (CFP, CPA, MBA), he remains confident that he can still keep investing simple.

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I am Allan Roth, the founder of Wealth Logic, an hourly-based financial planning firm in Colorado Springs, Colorado. With a strong background in finance and behavioral finance, I have taught at universities and contributed to national publications such as The Wall Street Journal and Money magazine. My credentials, including CFP, CPA, and MBA, underscore my expertise in the field. Today, I will leverage my knowledge to discuss the key concepts mentioned in the article "Money - Here are some rules if you're feeling lucky."

The article discusses the author's investment strategy, emphasizing the core of their stock portfolio consisting of a total U.S. stock index fund and a total international stock index fund. Despite the success of these funds, the author acknowledges the desire to engage in more speculative and enjoyable stock picking. The focus is on setting rules for this "gambling portfolio" while recognizing the thrill and unpredictability associated with picking individual stocks.

Here are the key concepts from the article:

  1. Diversification: The author advocates for a diversified portfolio by owning a total U.S. stock index fund and a total international stock index fund. Diversification is a risk management strategy that involves spreading investments across different assets to reduce exposure to any single investment.

  2. Individual Stock Picking: The article explores the author's inclination to pick individual stocks for enjoyment, despite the success of index funds. The top-performing stocks in the S&P 500 from 2000 to 2020 are listed, and the author expresses the excitement of potentially owning such high performers.

  3. Unpredictability of the Market: The author reflects on the unpredictability of the market, especially in the context of the year 2020, which was marked by significant volatility and unexpected events like the COVID-19 pandemic.

  4. Speculative Investing: The article introduces the concept of a "gambling portfolio," where the author allocates a small portion of their investments to ultra-risky individual stocks that have fallen from grace. This approach is acknowledged as risky but is seen as a source of thrill and fun.

  5. Investment Rules: The author emphasizes the importance of having personal rules for investing. In this case, the rule is to invest in stocks that have fallen from grace and have about a 50-50 chance of going bankrupt. The rationale is that such companies, if they outperform low expectations, may experience a rise in stock prices.

  6. Risk Management: The author mentions that, while the speculative approach is part of their portfolio, they only bet what they can afford to lose—typically less than 5 percent of their total portfolio. This highlights the importance of risk management in investment strategies.

  7. Core-and-Casino Approach: The author refers to their overall investment strategy as a "core-and-casino approach," where the core consists of logical and dull index funds, and the casino represents the risky business stocks chosen for the thrill.

  8. Long-Term Perspective: Despite the occasional urge to engage in speculative investing, the author acknowledges the long-term perspective of their core investments in index funds. This perspective aligns with a disciplined and strategic approach to wealth accumulation.

In summary, the article provides insights into the author's investment philosophy, balancing the stability of index funds with the excitement of individual stock picking while emphasizing the importance of personal rules and risk management in investing.

Should You Buy Individual Stocks or Stick to Mutual Funds? (2024)

FAQs

Should You Buy Individual Stocks or Stick to Mutual Funds? ›

A mutual fund provides diversification through exposure to a multitude of stocks. The reason that owning shares in a mutual fund is recommended over owning a single stock is that an individual stock carries more risk than a mutual fund. This type of risk is known as unsystematic risk.

Is it better to buy individual stocks or mutual funds? ›

Mutual funds are typically more diversified, low-cost, and convenient than investing in individual securities, and they're professionally managed.

Which are a better investment stocks or mutual funds explain your answer? ›

Stocks are more appropriate for investors who can monitor their portfolios and the stock market for opportunities. Mutual funds are more suitable for investors who want a fund manager to do all of the work for them. Bernat summarizes what investors should consider before choosing the right approach for their portfolio.

Should you buy and hold individual stocks? ›

If you have enough money to invest, are willing to accept the risk and want a high degree of involvement, individual stocks may be a good choice. Potential Growth of Principal – Stocks have a long track record of providing higher returns than bonds or cash-alternative investments.

Why should an individual invest in mutual funds? ›

Mutual funds offer diversification or access to a wider variety of investments than an individual investor could afford to buy. There are economies of scale in investing with a group. Monthly contributions help the investor's assets grow. Funds are more liquid because they tend to be less volatile.

Why invest in stocks rather than mutual funds? ›

Higher returns

When you invest in stocks, you put more of your money in one place. That reality typically translates to higher potential returns than do mutual funds. It can also mean, however, a greater risk because you are now more impacted by the up-and-down fluctuations that come naturally to stocks.

Should you only invest in mutual funds? ›

All investments carry some risk, but mutual funds are typically considered a safer investment than purchasing individual stocks. Since they hold many company stocks within one investment, they offer more diversification than owning one or two individual stocks.

What are the disadvantages of single stocks? ›

Cons include more difficulty diversifying your portfolio, a potential need for more time invested in your portfolio, and a greater responsibility to avoid emotional buying and selling as the market fluctuates.

Is it good time to invest in mutual funds now? ›

There is no better time to start investing. It is very difficult to time the markets and although the markets are due for a correction, it would not be wise to wait further. Also, when it comes to SIPs, there is not much merit in timing the markets. We would suggest you invest in different mutual fund categories.

How much should you invest in mutual funds? ›

To determine how much to invest in Mutual Funds monthly, subtract your monthly expenses including contributions to your emergency fund and short-term goals from your monthly income. The remainder is what you can allocate to investments.

Why I stopped picking individual stocks? ›

The risks are too great with individual stocks

“They often don't know how to do due diligence or research companies. So they're often going to pick stocks without the information they need to make good decisions.” Benz's original statement from June 2020 rings even truer in hindsight.

How long should you hold individual stocks? ›

If your stock gains more than 20% from the ideal buy point within three weeks of a proper breakout, hold it for at least eight weeks. (The week of the breakout counts as week 1.) If a stock has the power to jump more than 20% so quickly out of a proper chart pattern, it could have what it takes to become a huge winner.

How long should you hold a single stock? ›

Though there is no ideal time for holding stock, you should stay invested for at least 1-1.5 years.

Why do people prefer mutual fund? ›

Mutual funds are popular in part because they offer investors the opportunity to diversify, and therefore spread out their risk over a number of investments. Mutual funds appeal to people because they give average investors the opportunity to invest in professionally managed funds.

What are the cons of mutual funds? ›

Potential for loss: Mutual funds are not FDIC insured and may lose principal and fluctuate in value. Cost: A mutual fund may incur sales charges either up-front or on the back end that are passed on to the investors. In addition, some mutual funds can have high management fees.

Why is investing in individual stocks riskier than investing in mutual funds? ›

Buying stocks means you get to own a part of an individual company represented by that stock. This investment offers potentially higher returns if you invest in companies having strong growth potential. But this investment is also riskier than MFs as it carries higher volatility.

Are individual stocks more tax efficient than mutual funds? ›

An additional tax efficiency advantage that stocks have over mutual funds includes no inherited capital gains. Inherited capital gains occur within stock mutual funds because every current owner of the fund shares in the annual capital gains tax associated with the entire fund yearly.

How many individual stocks should you own? ›

There might be other practical considerations that limit the number of stocks. However, our analysis demonstrates that, whether you own ETFs, mutual funds, or a basket of individual stocks, a well-diversified portfolio requires owning more than 20-30 stocks.

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