- Investing in Individual stocks can yield higher returns for your portfolio.
- Individual stocks also offer the investor more control, lower management fees, and greater tax-efficiency.
- Individual stock investing takes more time and research.
- It can be harder to achieve diversification and avoid emotion with Individual stocks, increasing the risk for portfolios.
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; as a result, 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, investing in particular equities can increase your returns, often dramatically.
It’s certainly an investment approach to consider for your Roth IRA. Read on to see if it’s right for you.
If you’ve never picked your own stocks, read some books on the topic. Start with basic-level books, such as Stock Investing For Dummies by Paul Mladjenovic, to learn the lingo and how the process works. You can then read more sophisticated works, as you get more comfortable with the subject.
Of course, there are hundreds of investing strategies out there.
One of the most time-honored ways is to pick stocks of companies whose stock is “undervalued,” which means that their share price is lower than the company’s intrinsic worth, signaling that they’re out of favor with the current market. Prospects for value investors, as followers of this strategy, are known, 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.
Another strategy is growth stocks investing. As the name implies, the idea here is to invest in companies that are growing their earnings by very high percentages each year—or that are poised to do so. They are innovators or game-changers in their industry or the leaders in a new one. Wouldn’t you have liked to have bought a piece of Apple, Google (now Alphabet), Amazon, or NetFlix, back in the day?
Growth company stocks won’t have much history, which makes them riskier prospects, and they best suit a long-term investment horizon. Don’t count on much dividend income from them at first, either.
Yet a third type of investment strategy, market timing, is the act of moving in and out of equities based on how the entire financial market is performing. While feasible for traders, portfolio managers, and other financial professionals, market timing can be difficult for the average individual investor, unless he wants to spend a lot of time in front of a computer screen. And a “buy-and-hold” strategy usually works better in the long run, as the stock market has historically appreciated in value.
In the short term, though, market timing can work. Fans of the strategy say it allows them to realize larger profits and minimize losses by moving out of sectors before a dramatic rise or drop.
The Rewards of Picking Individual Stocks
Whatever strategy you chose, investing in individual equities takes time and effort. But there are rewards.
You have complete control of what you are invested in, and you understand what you own when you pick out the stock.
When buying individual stocks, you see reduced fees. You no longer have to pay a mutual fund company an annual management fee for investing your assets. Since fees have a big impact on your return, this alone is a good reason to own individual stocks. You’ll pay a brokerage commission when you buy the stock and when you sell it. The rest of the time there are no additional costs. The longer you hold the stock, the lower your cost of ownership is.
It is easier to manage the taxes on your individual stocks. You are in charge of when you sell, so you control the timing of taking your capital gains or losses. When you invest in a mutual fund, the fund determines when to take the gains or losses and you are assigned your portion of gains. You could end up paying for a year’s worth, even if you just bought into the fund at the end of the year.
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.
The Risks of Picking Individual Stocks
The risks of picking individual stocks are real, which is why most people tend to avoid doing it. Along with the opportunity for incredible gains—and deflating losses:
- 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.”
Adding to the risk: With individual stocks, it is harder to be diversified, which cushions your portfolio against volatility. Depending on what study you are looking at, you need to own between 20 and 100 stocks to achieve adequate diversification and portfolio protection.
Hire a Pro
If you decide that stock picking isn’t for you, you can hire an investment manager to do it for you. Investment managers have discretionary powers to trade your account; in return, they are compensated by an annual fee, a percentage of the value of the portfolio. If you go this route, be sure to go with someone who has trusted referrals (yours, not his) and a verifiable track record of matching or outperforming the market. Or, you can keep most of your portfolio in mutual funds or a managed account, then work with a small percentage, say 10-20% in your own stock picks.
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.
If you’re going it alone, you will need to trade through a brokerage firm that can act as a custodian for Roth IRAs. Our brokerage comparison page can help to identify the right firm for you,