I’ve been thinking about how to be more conscientious with my money. Sure, there are tax-free donations and values-based spending, but what if there was a world where I could invest in companies I believe in? Specifically, companies who believe in reducing the racial wealth gap, climate change, and reproductive rights? Well, guess what? You can buy individual stocks in those companies, though (as always) there are pros and cons.
How do I get started? And is that the financially smart thing to do, especially in a bear market with a recession looming? Let’s get into it.
Here’s a closer look at the pros and cons of buying individual stocks:
The pros of buying individual stocks
You might consider buying individual stocks as a retail investor for several reasons.
Individual stocks allow investors to invest in companies that align with their values. You can choose to invest in environmentally friendly companies that support social causes or have business practices that you agree with. This way, your investment is not only growing financially (hopefully) but also supporting causes and businesses that you believe in.
Additionally, buying individual stocks gives you more control over your investment. You can choose to sell your shares at any time and are not tied to the performance of a particular index or fund.
Another benefit of buying individual stocks is building a diversified portfolio without investing much money. Investing in different companies can spread your risk and potentially reduce any losses.
The cons of buying individual stocks
Now that you know the pros of purchasing individual stocks, let’s go over the cons. Because you’re investing in a specific company, your investment is subject to that company’s performance. If the company doesn’t do well, your investment will likely suffer.
Additionally, individual stocks can be more volatile than other types of investments. That means they can increase and decrease in value more frequently, making it challenging to earn a consistent return on your investment.
How do stock pickers perform statistically?
It’s no secret that most stock pickers underperform the market. In fact, a study by Vanguard found that 88% of active stock managers failed to beat their benchmark indexes over a 10-year period.
There are many reasons why individual stock picking is so tricky. For one, finding stocks that will outperform the market consistently is challenging. Even if you find a few winners, it’s tough to avoid selling too soon (out of fear of missing out on further gains) or selling too late (and watching your profits evaporate).
But even though the odds are stacked against individual stock pickers, that doesn’t stop millions of people from trying their hand at it every year. In fact, a study by J.P. Morgan found that individual investors trade stocks an average of 4.6 times per year, nearly twice as often as professional investors.
Retail investors tend to be even more active, with some studies finding that they trade stocks an average of 12 times per year.
Why do people keep trying to beat the market when the odds are so stacked against them?
One reason is that people simply don’t understand how difficult it is to find and hold on to winning stocks. They see other people making money in the stock market and think it must be easy. After all, in a bull market, everyone is making money. When bull markets turn into bear markets, however, it’s a lot harder to keep those gains going.
People also have difficulty accepting that they can’t control everything. For many, buying stocks is a way to feel like they’re in control of their financial future.
Emotions and stock picking
You’re subject to your own emotions and reactions when you buy individual stocks. You see something happen in the world or trending on TikTok, and you respond quickly. You might sell when the stock price drops, even if it’s only temporary. Or, you might hold on to a stock that’s not performing well, hoping it will rebound.
This can be risky because you’re making decisions based on how you feel rather than on a logical analysis of the stock. Quickly changing emotions can lead to impulsive decisions that cost you money.
It’s important to remember that stock prices go up and down all the time. So even if you conduct some research and find a good company with solid fundamentals, there’s no guarantee that the stock price will go up. In fact, it could go down in the short term.
Consequently, buying individual stocks is generally considered a more risky investment than investing in a diversified portfolio of stocks, which can help minimize your losses if any individual stock drops in value.
So, should you buy individual stocks? It depends on your risk tolerance and investment goals.
Figuring out your investment goals and how investing in individual stocks fits in:
There’s no one-size-fits-all answer to how to define your investment goals. When deciding if investing in individual stocks makes sense for you, consider whether the pros outweigh the inevitable cons. Some key considerations can help you zero in on what’s most important to you.
First, think about your overall financial picture. What are your long-term goals? Do you want to retire early? Buy a home? Send your kids to college? Once you have a sense of your bigger financial picture, you can start to think about how investing can help you reach those goals.
Next, consider your time horizon. How much time do you have to invest? If you’re closer to retirement, you’ll likely want to focus on stability and income rather than growth. On the other hand, if you’re younger and have a longer time horizon, you can afford to take more risks in pursuit of higher returns.
Finally, think about your tolerance for risk. Are you the type of person who’s comfortable with a bit of volatility, or do you prefer a steadier investment approach? If you’re willing to take on more risk, buying individual stocks could be a good option. Alternatively, you might want to consider other options if you’re looking for a less risky investment.
Most importantly, your investment goals should be specific, measurable, achievable, relevant, and time-bound. In other words, they should be tailored to your unique financial situation and objectives.
Alternatives to investing in individual stocks
What are mutual funds?
A mutual fund is an investment vehicle comprised of a pool of money from many different investors. The money in the fund is used to purchase various securities, like stocks, bonds, and other investments.
Mutual funds are an ideal way for investors to diversify their portfolios. This way, you’ll get exposure to various asset classes.
There are many benefits of investing in mutual funds, including:
- Diversification: Mutual funds offer investors the ability to diversify their portfolios across multiple asset classes and investment strategies.
- Professional Management: Professional money managers with experience in making sound investment decisions oversee mutual funds.
- Affordability: Mutual funds are a relatively affordable way for investors to get exposure to a wide range of securities.
What are the risks of investing in mutual funds?
- Market Risk: Mutual funds are subject to market risk, the risk that the securities or investments in the fund will lose value.
- Interest Rate Risk: Mutual funds are also subject to interest rate risk, the risk that the fund’s value will decline if interest rates rise.
- Credit Risk: Mutual funds may be subject to the risk that the issuer of a security in the fund will default on its obligations.
What are index funds?
Index funds are mutual funds that track a specific market index, such as the S&P 500 or the Dow Jones Industrial Average. Index funds are an excellent way for investors to get broad-based exposure to the stock market.
The main difference between mutual funds and index funds is that a fund manager actively manages mutual funds, while index funds are passively managed.
There are many benefits of investing in index funds, including:
- Diversification: Index funds offer investors the ability to diversify their portfolios across various securities.
- Passive Management: Index funds are passively managed, requiring little to no maintenance fees.
- Low Cost: Index funds typically have lower expense ratios than actively managed mutual funds.
What are the risks of investing in index funds?
Index funds are subject to the same risks as mutual funds, including market risk, interest rate risk, and credit risk. However, because index funds are passively managed, management may not actively reduce the risk of financial losses.
So, should you pick stocks?
So, should you buy individual stocks? It depends on your circumstances and goals. If you’re willing to take on more risk for the potential of higher rewards, then investing in individual stocks may be right for you. However, if you’re not comfortable with that level of risk, it may be better to stick with more traditional investments like index funds.
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