30 August, 2022 Tax Planning

Should You Own Individual Stocks?

For various reasons, stock trading for retail investors has become more and more mainstream in recent years.

Having concentrated positions in individual stocks offers the potential for greater gains when compared to bonds and diversified holdings of stocks. However, like anything there are trade-offs. 

Despite this potential, I’m going to argue that most people should not buy individual stocks.

Stock picking is a lot harder than it sounds. In fact, most individual stocks don’t actually perform well.

J.P Morgan analyzed the Russell 3000 Index, a benchmark for the entire U.S. stock market. 

As seen below, from 1980-2020 over 40% of stocks in the Russell 3000 experienced negative returns, while around 2/3 of stocks underperformed the Russell 3000

Only 10% of stocks in this time period can be defined as “Megawinners”

On the extreme end, 44% stocks in the Russell 3000 experienced a “catastrophic loss” defined as a decline of 70% from which it has not recovered. 

Historically, stock markets have provided incredible wealth to investors, but these gains have been concentrated in a small number of companies propping up all the other underperformers. To beat the index, you have to be smart enough to predict what those stocks will be going forward. 

The good news is that if you don’t feel like you can do this, you can own the entire market and not worry about all of this. For most people, this makes sense. If you try and pick individual stocks, statistically, you have a much bigger chance of picking a loser than a winner.

Compounding the difficulty of individual stock investing is that it’s not enough just to pick a good company. You also need to be able to value the company properly and pay a fair price for it. Even great businesses can be bad investments. 

Take Microsoft, one of the most successful and dominant companies ever. By all measures, it’s been a fantastic business for decades now. 

However, if you happened to buy Microsoft stock at its peak price in 2000, right before the tech bubble burst, it would have taken you over 14 years to break even

Picking stocks is so hard that even professional investors struggle to do it over long periods. 

According to SPIVA, over the 10-year period ending December 31, 2021, over 83% of US large-cap stock funds underperformed their benchmark (S&P 500).  

That’s not counting any retail investors picking stocks for themselves at home. This compares professional money managers with massive research and analyst teams. 

These are the professionals you compete against when you invest in stocks, and even they largely struggle to match their benchmarks.

Just because these professional managers have overwhelmingly done worse than buying an index, doesn’t mean you will as well. But the odds aren’t in your favor. 

All of this notwithstanding, if you’re currently investing in individual stocks, none of this will likely change your mind. 

Investing in companies you recognize is a lot more fun than investing in index funds. It doesn’t matter that investing shouldn’t be about having fun, but it’s only human nature. 

It’s also human nature to get tempted by the potential of picking the next Amazon or Apple. Or, you’ve probably heard a friend brag about much money they made from a stock (be skeptical of this- they’re likely leaving out other investments that haven’t done as well). 

Just make sure the temptation doesn’t get out of control. If you want to invest in individual stocks, keep it to around 5-10% of your portfolio to help get it out of your system, and invest the rest in something more diversified. Your money is too important to play with.

 

*The views and opinions expressed in this article may not necessarily reflect those of IPC Securities Corporation.

1https://www.spglobal.com/spdji/en/research-insights/spiva/#us