I don’t own any shares of stock. I also own shares of every publicly traded company in America.
Sound like a contradiction?
The key to this paradox is the existence of index funds. I invest my money into a fund with a bunch of other investors. The fund uses the collective pool of money to buy stocks. I technically own shares of the fund itself, and therefore indirectly own the stocks.
This is the best strategy that I’ve found for investing. Whether or not it’s the best strategy overall can be debated (although I’d be on the “yes, it is” side), but one thing that is unquestionable is that it’s the easiest. And being the easiest almost automatically makes it the best option for most people.
But it’s not the only option. Many people want to try their luck at buying and selling the stocks of individual companies.
There’s something tempting about trying to pick the next big investment, but it’s not tempting enough for me to try. Here are the reasons why I stay away from single stocks.
We all know the phrase: Never put all your eggs in one basket.
When you buy an individual stock, you’re putting your money in a basket. When you buy a share of a total stock market index fund, you’re putting your money into thousands of baskets.
The magic that makes this work is the concept of a mutual fund. If you have a dollar to invest, it’s going to be impossible to diversify by buying individual stocks. In fact, you probably don’t even have enough to buy a single share.
But with a mutual fund, everyone’s money gets pooled together. I invest. You invest. Some guy from Cincinnati invests. We all share ownership of the fund, and the fund buys stocks with a large pool of money that can be diversified across categories and industries.
Some mutual funds are actively managed by a professional who is buying and selling stocks trying to beat the market. I prefer low-cost index funds, which just seek to replicate the current state of the market. So if Apple is 4% of the market, 4% of the fund’s money gets invested in Apple. Maybe 3% goes to Microsoft and Amazon, and so on.
Because I own a share of the fund and the fund owns the stocks, literally every dollar I invest is instantly diversified across thousands of companies.
Because I own a bit of every company, I don’t have to worry about how well any company is doing. This is the beauty of an index fund. What if Wal-Mart declares bankruptcy? That’s fine, I own Target. Oh, you heard that Mastercard was going under? I own Visa too. Forecasts say that financial stocks are going to struggle? I’m also invested in tech. And healthcare. And energy…
Too Much Time and Energy
When you invest in every company, you don’t have to know anything about any company.
When you buy a single stock, you sure as heck better know it’s a good investment.
Think about it this way. Every time you buy a stock, someone is selling it. Every time you sell a stock, someone is buying it. If you’re both trying to make money off of individual stocks, you’re betting against each other every time a transaction happens. They think the price is going to go down, so they sell. You think it’s going to go up, so you buy.
You could get the return of the market as a whole if you invested in a total stock market index fund. But if you’re going to try to beat the market by investing in individual stocks, you’re competing against everyone trying to do the same thing.
Many of them are spending all their time studying companies looking for an edge. Do you have the bandwidth to compete with that? What’s your edge? Will you do more research? Do you have better intuition? Or are you just planning on getting lucky?
Most people who trade individual stocks end up racking up huge transaction costs. They also need to be very careful about taxes.
Costs are something that most people don’t think much about. But they make a big difference over time. Remember, if you’re trading individual stocks, you’re engaged in a zero sum game with other investors. But it’s not enough to beat the other investors, you have to beat other investors by enough to beat the market net of taxes and fees.
That’s not easy.
I’m reading a great book right now called The Psychology of Money by Morgan Housel. One of the things he points out is that it’s really difficult for humans to be rational all the time. The best we can hope for is to try to be reasonable.
It’s reasonable to invest in a company like Tesla if you love the company and want to feel like you’re part of what they are doing.
Personally, I don’t have any enthusiasm for any company out there. I invest to make money, not to say that I own part of some business in particular.
If I wanted to make a more speculative investment, I would probably invest in a cryptocurrency, not an individual stock.
How to Have Fun and Stay Responsible
So am I saying that no one out there should invest in single stocks? No.
It’s fine to invest in individual stocks if you really love it. You should do it if you love trying to beat the market. You should do it if you love particular companies.
But you probably shouldn’t do it with all your money.
The bottom line is that there’s more risk and less diversification when it comes to investing in individual stocks.
One approach to investing wisely when you’re tempted to make speculative investments is to use the 90/10 rule. Essentially, the idea is to put 90% of your contributions into a boring index fund. The other 10% is yours to play with.
But that’s all you get. If you lose it all, you can’t sell your boring investment to buy your speculative investment.
Buying single stocks means more time and energy for less diversification. It’s not a trade that makes sense to me.
Since I have no strong desire to own individual companies, I don’t buy single stocks.
If you want to own single stocks, I’m not here to tell you that you can’t. But I’d encourage you to consider whether you’re better off having most of your money in boring investments and playing around with the remaining 10% off to the side.