I write about investing, so the people I meet often think I have secret stock tips up my sleeve. What tiny tech company might become the next Apple? Should they buy Facebook or sell it?
Sorry, guys. I don’t know and I don’t even want to think about it. Picking stocks is a loser’s game. That’s true not only for average investors who have day jobs (including me) but for financial professionals, too.
The majority of mutual fund managers, who spend their lives looking at company data, don’t pick stocks that beat the market over time.
But first, here’s my seven-point case against buying individual stocks:
1. A stock isn’t just a piece of paper, it’s a share in an actual corporation. If you’re thinking of buying it, what do you know about the company’s operations? What are the trends in sales, inventories, expenses and profit margins? Which lines of business are strong and which are weak? What’s the competition doing? Is market share rising or falling? Are new products coming on line fast enough? What are the company’s problems and does management have a plan to fix them? Most likely, you don’t know the answer to these questions, so you can’t really judge whether the stock it worth its price.
2. Investors don’t even understand what’s going on in the corporation they work for. Look at the number of employees who owned shares in WorldCom, Enron, Lehman Brothers and other firms that went broke. Think of the employees at Citigroup, whose stock dropped 97 percent in the 2008 crash. They had confidence in their own work and the work of their colleagues, but had no idea of mess top management was making.
3. Individuals tend to buy stocks that are in the news. But when everyone is talking about particular companies – Internet, tech, dividend payers or whatever — those companies are probably already highly priced. Their stocks might rise further, but not as fast as the market as a whole. Next year’s winners will probably be companies whose names you don’t recognize today.
4. Great companies don’t necessarily make great stocks. For example, take Microsoft. It still dominates its business but the stock limps along at 58 percent below its 2000 high. General Electric is still down 60 percent. Meanwhile, the broad market has almost fully recovered. Other stocks left Microsoft and GE in the dust. This story makes me wonder about Apple – it’s a great company but is it still a great stock? I dunno.
5. You’re not well-diversified when you buy individual stocks. You might own mostly large companies and few small ones, or mostly tech stocks and nothing in manufacturing. Your investments will do well when your favorite industries do well and lag when other types of stocks go up. Research suggests that, to diversify properly, you need to own at least 50 stocks – in large companies and small ones, growth companies and value companies, and in many different types of industries. Who does that?
6. It’s too easy to kid yourself, when you own a portfolio of individual stocks. You remember your winners, every single one of them. You forget your losers. You never average the two together, so you have no idea whether you’re doing well, overall, and how your investments compare with the market as a whole. Lots of research says that you’re probably doing worse than the market, and don’t know it. Remember: It’s not enough for a stock to go up. To be worth your while, it has to go up faster than the market does. That means buying the right stock at a relatively low price, when few other people notice it. A stock whose performance merely matches the market isn’t worth the effort. You can match the market easily, by buying an index mutual fund.
7. Stock-pickers shouldn’t buy and hold. Very few companies are long-term stars. To do well with a stock portfolio, you have to keep weeding it – selling stocks that met your price goals (do you even have price goals?) or that disappointed you, and buying stocks that now look more promising. How good are you at pulling the trigger on losing stocks?
For all these reasons, I quit buying individual stocks long ago. I buy only mutual funds. Within the fund community, I don’t even buy most of the funds that are run by managers who pick individual stocks. They don’t have great long-term records, either. Stock-picking is only partly a game of reason and analysis. Mostly, it’s a game of chance.
My own investments are mostly mutual funds that don’t try to beat the market, they simply mimic the market as a whole. For example, take an index fund that follows Standard & Poor’s 500-stock average – a key measure of how the U.S. market is doing. The fund owns all 500 stocks in the index. When you buy, you’re diversified automatically and perform as well as the market does, minus fees.
There’s no sales charge when you buy from low-cost fund groups such as Vanguard and Fidelity. You can also buy index funds that follow international stocks (mostly developed countries, like those in Europe), emerging market stocks (the more exciting countries, such as those in Southeast Asia) and bonds. Many large financial institutions, such as pensions funds and insurance company, index part of their investments, too.
If picking stocks is your form of entertainment, please do it with only a small portion of your money. Buy, sell, chat, boast – have a good time. But do yourself and your family a favor and keep your life-changing money, including 401(k) money, in a group of low-cost index funds.