Should You Include Individual Stocks in Your Investment Portfolio?
In my early days as an investor, I followed a strategy advocated by financial guru Jeremy Siegel, in his classic book “Stocks for the Long Run”. Based on the historical data available at the time, he showed that investing in a portfolio of 10–20 dividend-producing stocks could beat the market.
I was using one of his variations: from the largest large-caps of the S&P500, I invested in the top ten dividend-producing stocks.
Three of those stocks were Bristol-Myers Squibb (BMY), AT&T (T), and Verizon (VZ). The other seven were all financial stocks.
Did I mention this was back in 2007?
In 2008 the market imploded in the “Great Recession”. Financial stocks led the way. One of those stocks that I owned, Washington Mutual, ceased to exist.
Since then, the rest of the stocks have recovered.
In the interim, dividend stocks have been losing to growth stocks.
But the point was that seventy percent of my portfolio was concentrated in one sector. This is an example of bad diversification.
In fairness, in the above example diversity would not have helped. If the entire market is going down, your stock is going down with it. But often, it’s only a single sector or even a single stock that tanks.
The market always comes back. But individual stocks may not.
Like Washington Mutual.
In a previous post, I talked about owning the stock of the company you work for, and the reasons that’s not a good idea either.
It used to be accepted practice that a portfolio of at least 20 stocks (5% each) had adequate diversification. Those early assumptions are being revisited, and even 30 stocks (3.33%) may be too few.
If you own an S&P500 index fund you own 500 stocks. Put your life savings there.
There’s usually a reason you decide to purchase a stock. It may be the company you work for or a company in a similar business that you know. It could be a product you know and enjoy.
Netflix (NFLX), Amazon (AMZN), Apple (AAPL).
Just because you like the company does NOT mean you should necessarily like the stock
The stock itself could be a poor value, or at the end of its growth run.
The problem is that we become emotionally attached to our stock.
This is not good. Buying and selling decisions should be completely objective, based on objective criteria we’ve determined ahead of time.
My elderly mother holds a great deal of General Electric (GE) stock. Several generations ago GE was the Apple of its day, on the cutting edge of innovative electronics. Shareholders were rewarded with a growing stock that paid good dividends.
I come from a long line of engineers. My grandfather worked for GE, as did my father.
To my mother, this stock represents our family that are no longer with us. As such, she has a difficult time parting with this stock that continues to drop year after year.
(It’s fortunate that my mother doesn’t need these dividends to live off…)
Stick to the S&P500. You’re less likely to become attached.
Anchoring is a variation of emotional attachment. We become anchored to the price we paid. How we feel about our stock is based on whether its “green” or “red”, have we made money or lost money relative to our purchase price.
However, our anchor has little to do with where the stock may go from here.
It may go green for a while, then start to reverse direction down. Because it’s still “green” we may not notice… until it’s too late.
The biggest issue with anchoring is that if we’re in the red we may refuse to sell until we are back to break-even, or our anchored purchase price.
Even though it may be better to sell at a loss and replace it by buying a different stock that is expected to rise in price.
Regardless of whether we are a trader or an investor, we will never buy or sell at the perfect time.
Our stock has gone up and we’ve made a tidy profit. We want to sell and “lock-in” our profit before the stock has a chance to reverse itself. We sell, only to see the stock continue to go up.
Our stock goes down. We are concerned it will go down further, so we sell. Instead, the stock turns around and goes back up again.
This happens in almost every stock transaction. We will never sell at the absolute top or buy at the absolute bottom.
We may suffer a bit of hindsight bias and think we can predict a top or bottom based on past moves. We can’t.
As long as “close enough” works to our advantage, we must accept it and move on.
The five stages
We’ve all heard of the five stages of grief by renowned psychiatrists Elisabeth Kubler-Ross: Denial, Anger, Bargaining, Depression, and Acceptance.
These five stages can be applied to any emotionally charged negative situation we find ourselves in.
If we’ve invested too much money in one stock or one area and it starts to unexpectantly drop, we may experience these stages.
Our first reaction may be denial. This denial will cause us to delay selling. While we work through the stages our stock may continue to drop.
Bargaining is a problematic stage. Avoid the temptation to buy more stock simply to try to make up the difference. This tactic rarely goes well, as the stock is more likely to continue dropping.
We may not sell until we work all the way to final acceptance. In the meantime, we may lose more than we intended.
It’s simply best to buy, hold, and rebalance.
Have one “trading” account
As a stock trader, I may sound a bit hypocritical. I buy and sell individual stocks (almost) every day.
However, zero of my long-term invested savings are in individual stocks. I now invest in mutual funds and exchange-traded funds only.
My trading follows very strict buying and selling rules. The stocks to me are an alphabet soup so that I avoid emotional attachment. ESNT, BABA, KKR, IBP, MHO…
Buying individual stocks for either trading or investing can be fun. However, if you do so, only invest a small amount. Only what you can afford to lose.
Before you hit the “buy” button decide where your “stop” is. Under what circumstances will you sell this stock? Both to the upside, and most importantly, to the downside.
Yes, Warren Buffett famously said that the best holding period for a stock was forever. But you and I are not Warren Buffett.
And yes, if you’d bought Facebook, or Netflix, or Amazon, or insert-famous-stock-here ten years ago you’d be a gazillionaire. But what about all the companies that didn’t make it? Or made it, but just did okay. That’s the majority. We forget about those, and “anchor” off the well-known stocks.
Write the stop price down where you won’t lose it. In your phone.
Don’t forget about the wash sale rule
I go into detail here. In short, if you sell a stock at a loss, then rebuy the stock-or something very similar-within 30 days, then you can’t recognize the first loss on your taxes. You must wait until you sell the second thing to recognize the gain or loss.
A big no-no is selling at a loss in one account, then buying it back in a tax-advantaged account. In that case, the loss is completely disallowed for taxes purposes.
If you must invest in stock, keep it restricted to one account only.
This information has been provided for educational purposes only and should not be considered financial advice. Any opinions expressed are my own and may not be appropriate in all cases. All efforts have been made to provide accurate information; however, mistakes happen, and laws change; information may not be accurate at the time you read this. Links are included for reference but should not be considered an implied endorsement of these organizations or their products. Please seek out a licensed professional for current advice specific to your situation.