When it comes to building wealth, investing is how you do it. This is how you put your money to work for you and essentially grow your money. From mistakes to wins, people talk about investing all day long. They are also quick to share their investing approach and why they think it's the best one. With everyone touting the "best investment approach", how do you determine what's best for you? Should it include buying individual stocks? Well, let's talk about that!
I get asked quite often whether or not it’s a good idea to invest in individual stocks. If you are reading this, you've also likely asked yourself, "Should I buy individual stocks?". In this article, I’m going to share my opinion on what I think about investing in individual stocks and who it’s best for. I'm also going to sharing some of the pros and cons of buying individual stocks.
What is a stock?
As a quick refresher and to give you context, a stock is essentially ownership in a company. Stocks are also known as shares and the holder of those shares is called a shareholder.
You can invest in individual companies by buying individual stocks. You can also purchase stocks by investing in vehicles like index funds or ETFs etc that aggregate the stocks of several different companies.
When is investing in individual stocks a good idea?
Investing in individual stocks can be a great addition to your portfolio. However whether or not you should invest in them depends on how you are currently invested. I like to look at it based on the current structure of your investment portfolio and your investing experience. Let's discuss.
Buying individual stocks as a new investor
As a new investor, when it comes to buying stocks, you don’t want to put all your eggs in one basket. Based on this, it’s a good idea to focus on having broad diversification in your portfolio. This is where you essentially mitigate your risk, by spreading your money across a variety of different investments. This could include different asset types (e.g. stocks, bonds, real estate, etc) and different industries (e.g. Technology, healthcare, consumer goods, etc).
ETFs and index funds are a better option than individual stocks because they offer broader diversification. As a result, they, in turn, help to minimize risk.
As a new investor, it’s also a good idea to focus on learning how investing works. Building knowledge around investing will make you an informed and confident investor. Especially when making investment decisions including investing in individual stocks and when is the best time for you to invest.
Buying individual stocks as an experienced investor
If you are an experienced investor, it's likely that you already have broad diversification. Based on this, it could make sense for you to invest in individual stocks. That being said, you still need to do your research to make sure that the individual stock investment makes sense for your portfolio and your long-term investing goals.
This means doing specific research to assess company risk, review financials, investigate company leadership track records, determine the company's future potential for growth, and more.
Pros and cons of buying individual stocks
You are in control of what you buy
When you invest in individual stocks you decide what stock you buy and how much you spend on each stock. This is different when you invest in funds. When you invest in a fund, you can only decide how much you invest. You have no say as to how your money is divided up across the different companies the fund invests in or when it's done. With individual stocks, you get to make these decisions.
You don't pay management fees
By investing in individual stocks, you don't have to worry about recurring management fees or expense ratios. You may pay a trading fee to buy the individual stock depending on your brokerage. However, that's about it when it comes to fees until it comes time to sell.
Diversification is limited
When you invest in an individual stock, all your money is in that one stock. You may be invested in multiple individual stocks but this is limited to how much money you have to invest in each company. And lower diversification and higher risk.
As a result, investing in individual stocks doesn't compare to the fact that index funds and ETFs for example, invest in hundreds and even thousands of stocks aggregated into a single fund. When you buy into a fund, your money is spread across all of these stocks.
You need to dedicate a lot of time
Since you have limited diversification when you are solely invested in individual funds, it's important to spend time tracking the performance of the companies you are invested in. You need to be aware of any big issues that could impact the value of your investments. If a company fails, you can lose your entire investment.
With funds, less time is required since your money is so widely invested. Big impacts to one stock in a fund can be absorbed by the rest of the fund without a lot of friction and without a total loss of your investment.
Focus on diversification
Establishing your investment strategy and in-turn building your portfolio should be based on your knowledge and your comfort level. Personally, I invest in some individual stocks based on my research and experience with the companies.
For example, I shop at Costo, I use Apple products and I keep up with what's happening with both of these companies. I however have the bulk of my stock market investments in index funds. This is the investing strategy that works best for me and my comfort level.
That being said, Individual stocks can be great for your portfolio but having broad diversification in a portfolio is the best approach. To learn more about how investing works, check out our completely free investing course bundle. And also pick up the Clever Girl Finance book, Learn How investing Works, Grow Your Money!