So you want to invest? AWESOME!! Maybe you have been reading a cool blog like mine or perhaps you had a friend tell you about this wonderful wealth building tool! Regardless, it will not be long before you question if you should buy individual stocks. With the bull market we are currently riding, there are many people that would tell you that it is a good idea. But is it really?
Often times when new investors come to my office, they want to invest small amounts of money into individual stocks. They are really excited about the market and understandably so. I had one guy come in and tell me that he invested $40,000 in an individual stock that actually turned into $110,000. That’s awesome!! Granted it took him 5 years to do it, but nonetheless, he did it.
Here’s the problem. When I asked him what type of account he was using, he looked at me funny and said, “I don’t know, I’m using cash.” Now, I’m not going to get into all the ramifications of this particular strategy, but there are two things to learn from his actions.
First, he was day trading. That is essentially where you buy and sell securities on the same day (or within a few days of purchase) based on slight fluctuations in pricing. This particular tactic is a hotly debated one that can make you a stack of money, then help you lose a lot of money just as quickly. It’s basically like going to Vegas, which we all know can be a lot of fun!
Next, he really didn’t see a $70,000 increase in his portfolio. Why do I say that? Capital gains taxes. He was paying taxes on the difference between his original investment and its current value. In the case, he was losing 25-30% of his earnings to taxes! Had he worked with a financial planner, chances are they may have helped him shield some of those earnings.
Now, on the flipside, I also see people in their late 30s and early 40s who are like, “Man I am never ever, ever buying an individual stock again!”
Many times between your early 20s and late 30s or 40s you’ve seen the bull turn into a bear and you lose confidence in the market. I know about a young investor that bought energy stocks some years back and his $10,000 portfolio grew to around $60,000. However, he didn’t protect himself and ended up losing most of that money. If I remember correctly, he cashed out for about $8,000.
It wasn’t necessarily the stock he bought was wrong, rather it was his investment strategy that cost him. For instance, right now, we’re in a bull market again and many are putting all their eggs in one basket. Many times I see this investor sentiment of, “Well, the market is really good. I really feel endowed right now, so I want to go out buy some individual equities. Besides, all my buddies are doing it and they’re making like 30% return.”
To those people, I say, “Possibly.” As an investor, I know the bear is coming and I prepare for it. I don’t know when it’s coming but I know it’s coming. That is why I am not a fan of day trading. I just don’t believe, that in the long run, it accomplishes what people are trying to achieve. To me, it doesn’t make sense.
I prefer to utilize modern portfolio theory and many times I may be able to see the exact same returns (or more) as those who are day trading. For me, I simply believe the markets are efficient.
There is a ton of data which shows you cannot outperform the markets on a long-term basis. If that were possible, then the active mutual fund managers would be able to do it. They have research teams, with highly educated people who track these things and the majority of times they can’t outperform the markets.
That brings us back to the question I received: “should I invest in individual stocks?” Well, if you work with me, I’m going to tell you no. I just don’t do it. I’m not a day trader. I don’t believe it works. I believe in building a highly diversified portfolio within your particular risk tolerance. Then I will rebalance the portfolio tactically as it is needed. This tactic is not sexy and it is not a tactic which will earn you bragging rights at a dinner table, but it will help you meet your overall financial goals. If the markets move up or down 20% – you don’t have to worry about it. You can let the markets work for you.
If you have questions about how to start investing, contact me and I’ll try to help you get started.