Although about 30% of my public equity portfolio is invested in individual stocks, I don’t recommend the average non-obsessed person invest more than 10% of their portfolio in individual stocks.
The main reason why is because it is hard to outperform the various indices over the long term. Although there are no fees for owning individual stocks versus owning index funds, there are bigger costs associated with owning individual stocks.
Namely, your time and attention! The loss of time and the need for your attention are the most important reasons not to invest in individual stocks. Unless you are an investing nut, you will have better things to do with your time and energy.
Recently, I was reminded about these much greater costs of owning individual stocks when Bed, Bath, and Beyond started shooting up like a rocket ship again. As a proud shareholder of BBBY, I was pleased!
Then I looked more closely at my rollover IRA.
Investing In Individual Stocks Requires A Lot Of Attention
Back in 2014, I bought a fixer-upper in the Golden Gate Heights neighborhood of San Francisco. At last, I had found an affordable panoramic ocean-view home!
As frugal folks, we decided to go to Bed, Bath, & Beyond to pick up some curtains, pillows and linens. While there, we were greeted by a friendly clerk who asked if he could help us find what we were looking for.
Somehow, Greg, the clerk, ended up telling me an inspiring story about how he’d gotten off the streets and overcome alcoholism. He’d been able to secure an affordable room in an apartment building and been sober for the past five years.
I was so inspired by Greg’s story that I decided to purchase $11,000 worth of Bed, Bath, and Beyond stock the next day in my rollover IRA. At the time, my rollover balance was around $400,000, so the position only accounted for about 2.8% of my portfolio. Also, it is in my rollover IRA where I will trade stocks due no tax consequences until withdrawal.
I’ve always enjoyed buying companies whose products I use. So I figured why not.
Meme Stock Mania Reignites
Given the position size of my Bed, Bath, & Beyond holdings, I forgot about the stock until I started seeing the recent headlines over Twitter talking about how BBBY was on fire! The stock was up over 400% in just a month!
The first thing I did was check my rollover IRA to see whether I still owned shares. You see, I didn’t even remember whether I did or not. And if I did, I didn’t remember how many shares I owned!
When I checked, I was dismayed. I only owned a measly 200 shares! Drat, that wasn’t even enough to take my family to Hawaii for 10 days. Even more dismaying was that even after the ramp-up, I was still down around 60% from my 2014 purchase price!
Due to the size of my initial purchase price of BBBY, I hadn’t paid close enough attention to the shares after purchase. So what happened since 2014 to cause BBBY to underperform by so much? Taking on too much debt and Amazon.
For the past decade, Amazon has been eating big box retailers for lunch. I knew this, everybody knew this. Heck, one of the reasons why I have owned Amazon shares for over 10 years is because I believed in this secular online trend. Yet, I still didn’t have the memory or make the rational conclusion to sell my BBBY stock.
Why Investing In Individual Stocks Is Hard
1) The lifecycle of individual companies is not forever. Plenty of big companies in the past no longer exist today for various reasons. Think Pan American Airways, Enron, Lehman Brothers, Worldcom, and Washington Mutual. As a result, no matter how strong an individual company may seem, you always have to pay some attention to it.
2) Competition is always intensifying. If a company makes a profit, economic theory states that other companies will compete until industry profits decline to zero. If profits decline to zero or negative for long enough, companies and industries get destroyed. Therefore, it is safer for long-term investors to invest in an index fund comprised of many companies. Investing in an index fund significantly reduces the possibility of losing money based on the destruction of companies and entire industries.
3) Volatility can be much greater. Some stocks move up and down greater than others. The more volatility a stock demonstrates, the more emotion you might feel. Extreme emotions such as greed and fear are the worst enemies of individual stock investors.
4) You might not own enough stock to make a difference. If you don’t know how to properly construct a risk-appropriate portfolio, your individual stock positions might not be significant enough for you to pay attention. When you don’t pay proper attention, you could let your losers lose for far too long.
5) You might own too many stocks to make a difference. On a similar vein, you might own so many individual stocks that you might not care what they do. The lack of discipline may also end up hurting your portfolio. At the same time, if you concentrate too much of your portfolio on one stock, you may be overly stressed and underperform if the company turns sour.
Index Funds Are Also Actively Managed
One thing index fund and index ETF investors might not realize is that these funds are also actively managed.
For example, there is an investment committee at Standard & Poor’s that decides which companies get to be included in the S&P 500 index. Tesla, for example, was included in the S&P 500 index on December 21, 2021. Tesla replaced Apartment Investment and Management REIT in the index.
If you own an iShares S&P 500 Index Fund, there is also an investment committee at BlackRock which buys and sells companies in its fund to mimic the changes in the S&P 500 index. The changes to the S&P 500 index and other large index funds are just generally slower than the changes in a typical actively run mutual fund.
As an investor, you are actually happy the S&P 500 is actively managed. Because at the end of the day, the investment committee at the S&P 500 wants to have a strong-performing index that reflects the health of the U.S. economy. Otherwise, another institution will come up with a better index fund.
You Have To Enjoy Investing To Invest In Individual Stocks
If you have no interest in reading about the stock market and economic news, listening to quarterly earnings calls, and analyzing companies, you probably shouldn’t be investing in individual stocks. You really must be obsessed with investing to own individual names.
For people who are interested in investing enough to read personal finance sites, I think the proper split between passive and active investing is about 90% passive index funds / 10% active individual stocks. After all, if you only invest in passive index funds, you’ll never be able to outperform the masses who only invest in passive index funds.
Even for investing enthusiasts, I think the most one should invest is 30% in individual stocks and active funds. Much more and you’re likely taking on too much active risk, which will likely cause long-term underperformance in your public equity portfolio.
Remember, roughly 80% of active equity fund managers underperform their respective indices over a 10-year period. Yes, we would all like to believe we are the 20% who outperform. But the data is against us. See the percentage of mutual funds underperforming over 10 years for yourself.
Keep Your Investing Simpler So You Can Be More Free
My main reason for investing now is so the investments can generate enough passive income so I can do what I want. I no longer want to spend a lot of time managing my investments. I’m simply too busy with fatherhood, writing, and tennis. One hour a week maximum is the most I’m willing to spend reviewing my investments.
When I was working in finance for 13 years and didn’t have kids, I was all over my investments. It was incredibly exciting to work in equities and invest in equities. It was my world where hunting for multi-bagger unicorns was a sport! Today, my world is my family.
As you get older, you will find that cash flow is more important than net worth. Cash flow is what’s real. Net worth is subjective. Net worth becomes a scorecard for your ego, especially once you have way more than you need to survive.
A Reminder To Pay More Attention To Equities
This latest absurdity in BBBY’s share price has reminded me to pay more attention to equities.
Although public equities account for about ~30% of my total net worth and are 100% passive, I still need to pay better attention. For years now, I’ve been letting the vast majority of my positions ride the bull market. Now things are shakier.
I will endeavor to invest at least 70% of my public equity portfolio in the S&P 500 and other indices. Then, I will be more purposeful in reviewing my individual stock holdings once a month.
Today, I mainly want to invest in long-term winners with defensible moats. Trading in and out of position is a waste of time. However, I do need to be vigilant about selling companies that are losing their competitive advantage.
The biggest benefit of investing in real estate and private funds is that they are more conducive to investing over the long term. Unlike stocks, I’m not worried my real estate holdings will decline by 30% one day after missing a quarterly estimate by 5%.
However, there’s also only so much physical real estate one can own before the pain of managing them is too much. Thankfully, we can now invest in real estate online for 100% passive income. The wealthier you get, the more you will be amenable to letting professionals manage your money for you.
What To Do With My Bed, Bath, And Beyond?
Will I sell my 200 shares of Bed, Bath, and Beyond? Yes. I sold half and will just hold onto the remaining 100 shares for entertainment. After all, what if it ends up being the next GameStop? The stock could also go to zero.
My BBBY stock is now worth less than 0.3% of my entire portfolio. So you see, investing in individual stocks plays with your head and wastes your time. Keep your investing simple!
Even though I’m down $6,000+ on my BBBY dog meat investment, at least I’m up a lot more on the property I bought in 2014. Psychologically, I’m going to take the estimated market value of my house and subtract $10,000. At least I got some nice curtains and linens!
Readers, what are some other disadvantages of investing in individual stocks? Have you had the reverse happen where you forgot about a stock that became a home run? How many individual stocks do you own and what percentage of your total portfolio is made up individual stocks?
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