Should I invest in individual stocks or should I invest in mutual funds?
This is one of the most common questions I get on my personal finance blog. While investing in individual stocks can be rewarding for many investors, here are the top reasons of why I only invest in mutual funds, index funds and ETFs.
1. Increased Risk
Why is investing in individual stocks risky? The biggest reason is that you don’t want to have all of your investment funds tied up in only a few individual stocks. When your money is not spread out over a wide variety of investments, you’re portfolio can take a huge loss if one of the individual companies that you’re invested in comes into trouble. Stock prices of individual companies can drop dramatically for a variety of reasons including poor management decisions, poor market conditions, major PR disaster (Think Tylenol Contamination Scare in the 80’s or more recently the BP Macondo incident). If you’re still interested in investing in individual stocks, it’s a good idea not to invest anymore than 10% of your net worth in any one company.
2. You’re Probably Not an Investment Analyst
Maybe you are a sophisticated investor, but chances are when it comes to picking stocks of individual companies you have no better idea than the next guy. I just don’t have the time to poor over the information necessary to make an informed decision on whether or not to buy a stock. Instead, I leave these decisions to professionals that manage a variety of low cost index funds that track the S&P 500, Dow 30, Russel 2000 and International Stock Fund.
3. Lack of Diversification
Not only are you placing your investment accounts at an increased risk when you invest in individual stocks, you’re also limiting your potential return on investment. You might get lucky and buy a stock right before it takes off, but your luck may run out soon and all those gains could disappear if the company has a bad day in the news. Having a properly diversified portfolio will give you more peace of mind and reduce the fluctuations in your investment account. You can read more about diversification in my article A Beginner’s Guide to Investment Risk.
4. Individual Stocks are Too Easy and Tempting to Sell
With today’s online brokerage options, it is almost “too easy” and tempting to sell your stocks. As you probably know, the longer you hold your stocks the better off you’ll be. Unfortunately for people with brokerage accounts, they tend to panic as soon as their stocks drop even a little bit and then sell; they move on to another stock and then sell again at the first sign of trouble. Not only are they selling the stocks for more than they bought them for, but they also pay a bunch of commissions to the brokerage company.
5. Day Trading Addiction
Last but not least, buying individual stocks ends up being gamble for most people don’t do their research. This “gambling” can quickly turn addictive to the investor especially have the have a few successful stock transactions early on. You can read about my own addiction to day trading through an online brokerage account on my website if you haven’t already.
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