I’m thinking about selling some of my mutual funds and exchange-traded funds and buying individual stocks. Is this a good idea for someone with moderate investing knowledge?
Managing a portfolio of stocks has a couple of key advantages. First, because there are no ongoing costs apart from trading commissions, it will cut your investing expenses to the bone. Second, it will allow you to tailor your exposure to specific companies and industries to suit your investing goals and risk tolerance.
But it’s not for everyone. Here are some questions to ask before you take the plunge.
How much time do you have?
The great thing about mutual funds and ETFs is that you can buy them and forget about them. With individual stocks, you’ll need to spend some time monitoring your holdings. How much time? Well, that depends. If you own a handful of blue-chip dividend stocks – banks, utilities, power producers and real estate investment trusts, for example – a couple of hours a week reading the financial pages and quarterly reports ought to suffice. But if you have a portfolio of, say, a dozen or more companies that includes anything slightly speculative (which I don’t recommend), then you could easily spend twice as much time monitoring your holdings, surfing message boards and reading analyst reports. My advice: If you’re going to own individual stocks, only buy the highest-quality names. Leave the risky stuff to the day traders.
How strong is your stomach?
When you own an individual stock, you get to watch it soar in price when the company announces positive news. The flip side is that, when the company misses earnings expectations or cuts its growth outlook, you’ll have to endure the pain of seeing your net worth shrink before your eyes. In extreme cases, you might even dump your shares just to make the bleeding stop. Learning to control your emotions and focus on the long term is imperative if you are going to own individual companies. If you don’t think you’ll be able to control your emotions, stick with mutual funds and ETFs. When a stock in the fund has a bad day, you might not even notice.
Are you a gambler?
Do you dream of finding the next ten-bagger? Do you think investing and gambling are basically the same thing? When marijuana stocks and cryptocurrencies were soaring, did you crave a piece of the action? If you answered yes to any of these questions, you might not be a good candidate for owning individual stocks. The most successful small investors do not take a lot of risk or shoot for the moon; they buy well-established, profitable companies that pay dividends and raise those dividends regularly. If you’re constantly looking for the next big score, you’re going to have an extremely volatile portfolio with a lot of stocks that may not pan out the way you had hoped.
Do you have a plan?
Another trait of successful investors is that they have a strategy, and they stick with it through good times and bad. For example, I’ve found that investing in stocks that raise their dividends regularly helps me to ignore volatility and focus on the growing stream of cash coming in. (See my model Yield Hog Dividend Growth portfolio.) Whatever strategy you follow – dividend investing, growth investing, value investing or a combination of all three – it’s important to maintain a diversified portfolio and measure your returns over years, not months or weeks.
Is it really worth it?
With the number of ETFs exploding and management expense ratios falling, it’s relatively easy to construct a well-diversified portfolio that will cost a small fraction of a percentage point in fees. Vanguard’s FTSE Canada All Cap Index ETF (VCN) and the iShares Core S&P/TSX Capped Composite Index ETF (XIC), for instance, both provide broad exposure to the Canadian market for an MER of just 0.06 per cent. That’s $60 a year on a $100,000 portfolio – or the cost of about six stock trades. You could well end up paying more than that in commissions if you buy individual companies. Generally, the larger the portfolio is, and the less trading you do, the more you’ll save by owning individual stocks. But you’ll have to balance the cost savings against the extra work and occasional stress that comes with managing a portfolio of stocks.
Is there a compromise?
Absolutely. If you like the diversification and low costs of index ETFs, but you also want to own a handful of individual companies, there’s no reason you can’t do both. There’s even a term for it: “Core and explore." Just make sure you don’t explore so far from your core that you end up with a lot of risky and speculative names. Whether you’re indexing or buying individual companies, remember that investing is not about making a fortune overnight but letting time and compounding work their magic. Keep your costs low and your trading to a minimum, and you’ll build wealth over the long run.
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