A personal finance blogger whom I respect a lot, Trent over at The Simple Dollar, posted a thought provoking piece this past week on investing in individual stocks where he discussed his feeling that buying individual stocks is like gambling.

While I agree with his eventual recommendation–that for the vast majority of investors (what I think Trent terms the casual investor) index funds are the way to go– and with one of his major points–that for those who can figure out the information available on the stock involved, they have a slight edge–I think investing in individual stocks has appeal in certain situations, for certain investors.

I own a handful of individual stocks, companies like Apple, Wells Fargo, Altria, and a few others. I’ve made lots of money on some, and lost on others. In all, I agree with Trent that if someone wants to get involved in individual stocks, they really need to do their homework to find winners. The upside is that if you do find a winner, it might be one that outpaces the stock market by a wide margin; however, if you find a loser, it could go to zero pretty quickly.

I consider investing in individual stocks to be a learning exercise; I have to do some math and read up on the company to consider if that’s somewhere I want to go. I also need to learn a little about the market they’re in and the products they make or services they provide. If I don’t understand the company or how they make money, I come to understand one thing: I’ve got no business investing in it.

In addition, I follow a few rules (which I occasionally break after a long discussion with myself) when selecting individual stocks:

1) Don’t buy penny stocks (something with a share price under $5);

2) Don’t exceed 5% of my total portfolio in any single stock;

3) Look for companies that pay dividends;

4) If you consider the company the best in their field–and they’ve got a track record of being profitable–it won’t hurt to own them!

Yes, you can probably sleep easier at night if you do as Trent has–go with index funds, and honestly, the vast majority of my investment money is indeed in index funds. But investing in individual stocks isn’t really like gambling. Instead, it’s an opportunity to possibly outperform the market and learn a lot about investing. So consider individual stocks for some of your investment dollars; you may learn a lot and gain a lot. But heed Trent’s words well: if you prefer sleeping at night to reading balance sheets and comparing price to earnings ratios, then index funds may be the way to go.

5 Responses to “Individual Stocks: Not Gambling, But Not For Everyone Either”

  1. Jason Ungeron 02 Apr 2008 at 6:09 pm

    My philosophy when it comes to owning individual stocks is that you have to be completely comfortable with the idea that you will lose all of that money.

    The reason you should diversify is so if one company does fail, your portfolio doesn’t go from something to nothing instantly.

  2. adminon 03 Apr 2008 at 10:22 pm

    Jason,

    I completely agree with the need to diversify and your reason for doing so. As in the original post, I always tell people to have no more than 5% of their portfolio in any single stock.

    I see your point re: owning individual stocks, but I’m not sure I think quite like that. I do, however, think that there is increased risk and to be prepared for that; but if you lose “only” 5% of your money, that’s a lot better than it could be!

  3. gameplanon 06 Apr 2008 at 8:13 am

    Hello from rainy England! I have stumbled across your blog on investing in individual stocks. I have invested in individual stocks for a few years and I found it too painful! All those great gains on some stocks going down the toilet on others.

    I have recently started investing in ETFs. Index investing doesn’t have to be boring. There are so many indices to pick from that you can build a watchlist with lower correlation and pick the index that is on the up – (you can probably tell I am a trend follower!)

    Any way keep up the good blogging!

  4. adminon 06 Apr 2008 at 8:57 pm

    Gameplan,

    Thanks. Nice to hear from a fellow investor, here in the USA or across the pond!

  5. [...] Ryan Suenaga from Uncommon Cents presents Individual Stocks: Not Gambling, but not for Everyone Either. [...]

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