When you think of the stock market, you may find yourself thinking about the performance of individual companies. We love to hear the stories of companies like Amazon or Apple, whose meteoric rise shows how small businesses can achieve great success, seemingly overnight. This could lead you to ask yourself a crucial question about investing: Should I invest in individual stocks?
Of course, there is no right or wrong answer, but it is essential to understand the risks and rewards of individual cherry picking actions for your portfolio. This article will explain the advantages and disadvantages of individual stocks and how they can influence your investment strategy.
What are individual actions?
If you are new to the world of investing, it may be helpful to review a simple definition of individual stocks. A “stock” confers ownership of a business. When you buy “shares” (basically units of shares), you are buying a certain percentage of ownership of that company.
So when we talk about individual shares, we’re talking about stocks that reflect ownership of a particular company. For example, if you choose to invest in Costco or IBM, each of these companies would be considered an individual share. If this sounds confusing, it’s because we use the term “individual stocks” to distinguish these stock purchases and a broader investment strategy, such as an index fund. Index funds are mutual funds or exchange traded funds (ETFs) composed of a diverse collection of stocks that reflect the performance of each company’s market index.
Why might you consider buying individual shares?
Before jumping straight in, you need to take a step back and consider what you want to achieve by buying individual stocks. Generally, there are three reasons to consider buying an individual stock.
Expect it to grow
The most obvious reason to invest in any business is to expect it to grow. With careful research and planning, you can discover a company that you believe has real growth potential. If your research is extended, you will be able to benefit from the success of the business.
You like the ethics of the company
Many of today’s investors want to put their money where their heart is. Maybe you like a company’s green initiatives or the way they support their local community. Whatever the exact reason, you may prefer to invest in a returning company.
You want dividends
Some companies pay dividends to their shareholders as a way to retain it. You may want to consider finding shares that pay dividends at regular intervals as an additional source of investment income.
The advantages of buying individual shares
There are some distinct advantages to acquiring individual shares, mainly because of the simplicity of the investment you make. Benefits include:
Typically, stock market investors pay a fund company or fund managers a commission to manage their stock market portfolio, typically a percentage of their overall income. But if you choose to invest in individual stocks, you won’t have to worry about those commissions. You will simply pay a commission to buy the shares and another commission to sell them.
When you choose your own stock, you will usually have more control over what you invest. You can choose when you want to buy; you decide when you want to sell. This can be especially true if you have been doing homework and have a greater knowledge of the company based on your research on the overall performance of the company.
In an investment fund, the fund determines when to take gains and losses. You will then be allocated a portion of your winnings, regardless of when you purchased the fund. But if you invest in individual stocks, you have total control over what and when you buy and sell. This means that you control the timing of gains and losses, which makes it easier to manage individual share taxes.
The disadvantages of buying individual shares
While individual actions can give you more control over your investments, there are some significant disadvantages to keep in mind:
It’s easy to dream of investing in the next big startup and see how your money piles up overnight. But this rarely happens, no matter how much research you do in a company. If you invest in a low-performing company, you are more likely to lose than if you had pursued a diversified portfolio.
According to a recent study, 90% of fund managers do not reach their financial benchmark. In other words, even trained professionals are not always experts in selecting high-performing stocks, which underscores the need for a diverse portfolio.
Any investment strategist will emphasize the need for diversification. Your portfolio should contain approximately 20 or more stocks to properly diversify, and some advisors will suggest up to 100. In fact, you can select individual stocks and create your own portfolio. However, it may be difficult to conduct the research necessary to strategically choose a diversity of stocks.
Greater investment in time
Finally, controlling any stock requires time and commitment. Fund managers do it for you, hence their commission, but it can be hard to find time to monitor the performance of your stocks if you have a day job. Not only that, but if you see that your action is sinking sharply, your emotions may improve, which will cause you to undo the actions at an inopportune time.
When to consider investing in individual stocks
Given these risks and benefits, you may be wondering if it is advisable to invest in individual stocks. But the answer is actually a resounding “yes”. Individual stocks can be a great addition to an existing stock portfolio, and that’s the real key. If you have already invested in the market through a diversified portfolio consisting of mutual funds, index funds or ETFs, adding individual stocks can be a great addition to your existing investment strategy. We consider how individual stocks can affect three different types of investors.
Young investors should generally focus on diversification. You can do this with mutual funds, ETFs and other financial vehicles. Sometimes, the guidance of a fund manager can be of great help in strategically pursuing diversification.
In general, this means that young investors should be cautious when buying individual stocks. When you are young, a diverse portfolio may include high-risk stocks, as you will have a lifetime to make adjustments to your portfolio.
If you decide to invest in individual stocks, do so carefully and slowly. Try to think of it as if you were walking towards a pool instead of jumping to the bottom. Buy a limited number of shares and never invest more than you can afford.
As an experienced investor, you are likely to have already achieved a high degree of diversification in the stock portfolio. If so, you may feel a little more free to invest in individual stocks, as long as you have done your research on the company, assessing its background, level of risk, and company leadership.
There is much debate about the wisdom of daily trading. During the 2020 pandemic, a whole new generation entered the world of investment. Day traders are based on buying and selling individual stocks and can even take advantage of market volatility to generate profits. However, their success stories are often denied by heartbreaking stories of tragic losses. Properly done daily trading requires considerable research and experience to navigate the market in the long run. The average investor will be better off pursuing a diversified and investing portfolio throughout their life.
Should I invest in individual stocks?
Are individual stocks solid investments? The best answer to this question is, “Sometimes!” No one can predict the future, which is why there are several portfolios and investment vehicles, such as index funds, to help mitigate risk.
This means that individual stocks can be fun to research and invest in, as long as you don’t put all your eggs in one basket. Focus on diversification, and then broaden your horizons once you’ve gained a little more experience. If you are really committed to a particular company, some mutual fund managers will give you some freedom when it comes to selecting stocks for your portfolio. They may also allow you to choose actions in a specific financial sector (e.g., technology, healthcare, etc.).
Do your research. Consider the characteristics of a business, such as the following:
- Financial history
- Current management
- Projected innovations
- Risk level
Again, there is no glass ball, but you can make individual stocks part of a balanced and diverse investment portfolio with the right mindset and careful planning.
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