In my last post, I discussed my process for selecting mutual funds in an employer-sponsored retirement account. Within the context of a 401k or 403b, the options we have for our investment dollars are a well-curated, limited number of options. Once we venture into other types of accounts, we tend to get exposed to a very wide variety of other options. While we still have access to mutual funds, (perhaps, the same ones as in our 401k) the list of options grows to a wide array of bonds, exchange-traded funds (ETFs), annuities, and individual stocks. And, I’m probably missing several other options.
Before I move on from employer-sponsored retirement accounts to the more self-motivated IRAs, I want to go over some reasons you might, or might not, want to venture into the world of investing in individual stocks. To be clear, you don’t have to include individual stocks in your investments to have a successful plan for your future. In fact, for many, it might actually be better to avoid buying shares of individual companies.
From a personal stand-point, I enjoy investing in individual stocks; it’s how I got started with investing in the first place. But, there a few questions you might want to ask yourself before you decide to buy the shares of individual companies versus letting someone else figure it out for you in a mutual fund or an ETF.
- Do you have a good foundation? (In terms of cash flow, your other investments, and knowledge of investing.)
- Do you really want to INVEST in individual stocks, or are you just speculating?
- If you are going to be investing, do you have the time to put in the work?
- Are you willing to endure the bumpier ride and single-stock risk that come with individual stock investing?
- Do you enjoy investing in individual companies?
A Good Foundation
So, what exactly is a good foundation for investing in individual stocks?
Financial Foundation: Cash Flow and Other Investments
First off, you have to have your cash flow in order. That means you are spending less money than you are earning, you are contributing to a retirement account*, and all of your credit card debts are paid. A mortgage is allowed; if you have low interest rates on a car loan or student loan, we’ll call that a “maybe.” I learned from experience that you can’t invest your way out of bad money habits. Even if you pick a winner that gives you a return that would outpace the interest on your debts, any downturn in your particular investment will be an extra nugget of stress in your life. It’s better to get these things in order to give yourself a clearer path and a clearer, more stress-free mind.
*One quick note: You should be contributing enough to your retirement account to maximize your employer match, and have a plan going forward to automatically increase your contributions until you reach an adequate level (consensus is 15% of pre-tax income).
Intellectual Foundation: Know What You’re Doing
When I say “know what you’re doing” in a foundational sense, I simply mean that you should know what a share of stock is. If you know that each share of stock you buy represents ownership of the company that issued those shares, then you’re on your way. If you didn’t already know that, then now you know.
And, in terms of investing, ownership involves certain responsibilities that separate the investors from the speculators.
Hey! That’s my next point…
Investing vs Speculating
The difference between investment and speculation, to me, is primarily in how much you educate yourself.
If you want to put your money to work by owning a company, you will want to review the company’s balance sheet and income statements, look over some recent filings, and listen to the most recent conference call (usually coinciding with a quarterly earnings report). All of these tools should be available to you either through your broker’s website or the company’s investor relations website.
Conference calls usually run around 45 minutes to an hour (I don’t always listen to the analyst Q&A part at the end), and can give you some insights into the company’s business and what items on the balance sheet you want to focus on (Revenues, Expenses, Debt Ratio, Profit Margins, Dividend Payout ratio and any et ceteras that may be important).
You’ll want to look over the company’s financial documents and listen to the conference calls before buying any shares, or fractional shares, of the companies you’ve chosen. It may be a little intimidating, at first, but you’ll be better off in the long run. Over time, these things will come more naturally and make more sense.
Will You Invest Your Time?
As you probably figured out from the above section, being an investor takes a little time. And, while the time demand for owning a company isn’t what I would call huge, that time tends to be concentrated in one of those quarterly months and is repeated for every company you own.
So, if you own shares in 10 companies, you might be committing around 30 or so hours every 3 months to keeping up-to-date on your investments. Those hours are likely to be a little concentrated in January, April, July, and October. The good news is that you can choose to spread the time out, somewhat, and that you may not need to listen to every conference call every single quarter (at least, for the larger, more well-known companies.)
If you want to own an individual stock, start with one or two companies to see if you can, and want to, do the research to stay on top your investments. And, also, make note of what you might need to give up to do this type of research (hobbies, time with family, classes to improve your other skills).
The Ride Can Get Bumpy
Any company you can name that has issued stock, you can also find a period of time where the market value of that stock has dropped by about 50% (or more); market downturns just happen sometimes.
Just this year, a company as large as Microsoft saw the price of its stock start the year around $160 per share, rise to over $188, fall back to just below $136, and has returned to the $190s.
|YTD as of 6/19/2020|
Now, I’m guessing that you like the first and 3rd line, and you like that final year-to-date line, all showing gains in value. But, that second line? I’m going to say you’re not a fan. And, while that 21.5% gain from 1/1 to 6/19 probably looks pretty good while we’re on this side of things looking back on it. The question is “could you have endured the ride in the middle of it?”
That price drop you see on the second line might not be of the 50% variety that I mentioned earlier, but consider that for every 10 shares of Microsoft you owned, you would have seen a loss of a little over $500.
But, James, wasn’t that part of a market-wide sell-off? Wouldn’t I have lost a lot of money in diversified mutual funds and ETFs? Yes, you would have lost some money.
Did some stocks hold up fairly well, or even go up, when the stock market was dropping? Also, yes. You might have even decided to own them. But, this market correction’s winners could be the next one’s duds; you have no way of knowing. One way or the other, you’ll have to keep your wits about you when things get crazy.
That’s why the previous sections of this post are so important. When you have a good foundation in your other investments, it cushions the bumps that go on with an individual company that you may own. When you’ve put in the effort to know that you own a good company that has good businesses and a good balance sheet, it eases the urge to sell when Mr. Market loses his mind; your desire might even be to buy more of that company.
You may still decide to sell your shares; that’s OK, too. But, if you’ve stuck to doing the work, it will be because you think either the company has gone bad, or the business that it’s in has gone bad. On occasion, companies have gone out of business, and the price of their shares has gone to $0. If you should decide to sell your shares in a company, doing the work will mean that your reasoning will be much more than a simple “because it was going down.”
Do You Actually Like This Stuff?
This last section, in my opinion, is the most important.
If you can do the work and take the ups and downs of owning individual stocks, it’s going to come down to how much you actually enjoy the process.
For every piece of time you spend learning about the companies you want to invest in and keeping tabs on your investments, you’re not improving your skills to get better at your current job, building a business, enjoying some other hobby, or spending more time with family (or, you could make investing a family affair; your younger kids will hate you for it now and love you for it later.).
So, if you don’t enjoy the process of investing in individual companies, it’s probably best for you to stick with mutual funds and ETFs where the stocks are picked for you and a professional fund manager does the leg work.
You (May) Never Know Until You Try
If you’ve read this far, and are still undecided as to whether you want to try your hand at investing in individual stocks, the only way to find out for sure is to try it out. Pick a stock or two to invest in, and contribute toward adding to your share count for 6-9 months. I think that should give you some idea about whether you really want to put in the effort to invest or if you’d enjoy other activities way, way more.
If you decide you want to buy some individual stocks, but take on a more speculative workload, that’s OK, too. You’ll just want to limit the amount of money you keep in those types of investments. (5% of your investments to speculation is probably OK…maybe a little more if you’re younger than 30 years old…definitely less if you’re over 55.)
Hopefully, you found this post helpful in deciding whether you want to enter the world of individual stocks or leave the decisions about your investment dollars to the pros. Individual stocks are how I got my start with investing, so it’s something that is near and dear to my investing heart.
Whether you invest in the shares of an individual company or stick with a collection of companies in mutual funds and ETFs, I hope it will make our discussions easier as we move to the more open world of IRAs and taxable investment accounts.
Thank you for visiting Finunciate. Come back soon.