There may be a way to get higher returns on your retirement investments if you have the talent to pick individual stocks—or if you can develop it. Mutual funds tend to track specific industry group performance or even the general market; they may do a little better than the averages, but usually not by much. If you’re willing to put in the time, especially the time to learn the process, picking individual stocks can increase your investment returns, often dramatically. How do you know if it’s right for you?
Individual Stocks: A Smart Investment Strategy?
Take the following into consideration as you look at various types of investment strategies for your Roth IRA:
How to Make Your Own Stock Picks
One of the most time-honored ways is to pick stocks of companies whose stock is “undervalued,” which means that they’re out of favor with the current market. This can include companies whose outstanding stock is worth less than the value of their net assets, have low price/earnings ratios (P/E), or are in bankruptcy but look poised to make a strong comeback.
The key is finding companies that have excellent long-term prospects despite recent price declines. A good example is a company with solid earnings and a strong financial position whose stock has fallen significantly because other companies in the same industry are in difficulty. The company itself is healthy, but its stock is low because of factors that have nothing to do with the company itself.
If you’ve never picked your own stocks, read some books on the topic, then ease into it slowly until you’re showing a pattern of success. Start with basic-level books, such as Stock Investing For Dummies by Paul Mladjenovic, then read some of the more popular ones as you get more comfortable with the subject matter.
The Rewards of Picking Individual Stocks
The ultimate payoff for an individual stock picker is beating the market—earning a return on investment that exceeds market norms. You might find a stock that rises many times over the price you paid for it, yielding spectacular returns. If you can accomplish this on a consistent basis you may be able to make money in all but the worst markets, and your retirement goals will be reached much more quickly. The whole goal of spending all that time researching and picking stocks is to beat the market average.
But few people ever reach this level, which is a good lead-in to the next discussion.
The Risks of Picking Individual Stocks
When picking individual stocks to invest in there is the opportunity for incredible gains—and deflating losses. There are a number of ways this can happen:
- Unexpected events can play out with a company, its industry or the general stock market that turn what looks like a sure winner into a crash-and-burn.
- You can become overconfident, so sure of your ability that you hold on to stocks too long, watching them fall to penny-stock status. Emotions play a huge part in the process.
- You could “lose your touch.” Some people do well at stock picking—for a time. It’s possible that after a few years of beating the market, you could fall behind it for the next few years. When this happens, it is easy to lose focus on your strategy and start making emotional investing moves to try to make up for your losses.
- You could over-trade, generating both losses and transaction fees. There’s a saying, ”Bulls make money, bears make money, but traders go broke.”
The risks of picking individual stocks are real, which is why most people tend to avoid doing it.
If you decide that stock picking isn’t for you, you can hire an investment manager to do it for you. If you go this route, be sure to go with someone who has trusted referrals (yours, not his) and a verifiable track record. Investment managers get paid whether they make money for you or not, so it’s critical that he’s demonstrated that he’s out-performing the market even after his fees have been paid.
No-load mutual funds are another alternative. They’re less personal than having your own investment manager, but they’re also far less expensive and have track records that can be verified by reliable third-party sources, like Morningstar or many popular investment publications (Money, Forbes, etc.). These mutual funds can be actively or passively/index managed.
A Balanced Approach
One of the best ways to begin picking your own stocks is to do it in conjunction with mutual funds or an investment manager. You can keep most of your portfolio in mutual funds or a managed account, then work with a small percentage (10-20 percent) in your own stock picks. This will give you the feel of investing with real money, but limit your losses in the event you make mistakes. You can increase the amount invested in your own picks as you build a track record and confidence in your own abilities.
How aggressive you can be with this can also depend on how much time you have before retirement. If you’re 30 to 40 years away, you can hit it harder. If you’re just a few years from when you plan to stop working, you might want to take it slower and invest less money in your own picks.
For the widest range of options for your Roth IRA, you will need to use a brokerage firm. Some investment firms only deal with mutual funds, but a discount or full-service brokerage will give you the largest number of options. For help identifying the right firm for you, check out our brokerage comparison page.
Have you ever tried picking your own stocks? Do you have any advice for others?