A couple of generations ago investing in stocks meant buying shares of a big-name company like Ma Bell, keeping them forever and enjoying dividend income along the way. But the boom in mutual funds in recent decades has created legions of investors who’ve never owned an individual stock.
Are they missing something?
In some respects, it’s easier to trade individual stocks now than in the good old days. A trade that once cost hundreds of dollars in commissions can be done online with a deep discount broker for $5 or $10. You can track prices, do research and place orders on your laptop, tablet or cellphone.
So why not dabble in stocks? When should you choose a stock over a fund?
[See: 7 Stocks to Buy When a Recession Hits.]
“It’s better to hold a stock when you are more confident that you’ve got a winner — when you really understand what the company does … and that they will outperform their peers in the future ” says Stan Bokov, chief operations officer at TradingView, a social media platform for individual investors. “It’s more work to research, but the potential upside is higher. However, the risk is higher as well.”
Some experts insist that owning individual stocks is too challenging for most ordinary investors. “In general, owning individual stocks is a bit of a sucker’s bet,” says Ryan McGuinness, president of CTR Financial in Lincolnshire, Illinois, citing factors like transaction costs and taxes.
But others acknowledge stocks have some advantages over funds and exchange-traded funds. Here are some of the considerations:
Big potential. For the legendary 10-bagger — a 1,000 percent gain — you need to bet on stocks, as a fund’s mix of winners and losers typically prevents extreme moves. Of course, an individual stock can be wiped out, too. You can lose lots of money in a bad mutual fund, but probably not everything.
Control. With a fund, the hard work is done by the asset managers. A stock investor can take all the credit for a winner — and the blame for a loser.
“Individual stocks can help create a tangible connection between investors and their money, by enabling them to invest in something they use themselves or see around them in their day-to-day lives — Johnson & Johnson (ticker: JNJ), Procter & Gamble (PG), Apple (AAPL), Netflix (NFLX), etc.” says Russell Robertson, owner of Alidade Wealth Partners in Atlanta.
Though he usually recommends ETFs for his customers, he sees a role for individual stocks. “It can also be useful if you want to take advantage of a specific area where there isn’t a good option in the fund/ETF world — liquefied natural gas, for example.”
Derek Tharp, founder of Conscious Capital in Cedar Rapids, Iowa, says stocks are more useful for investors with finely targeted goals, such as a focus on firms with certain ethical or environmental values
Quick moves. You can buy or sell a stock anytime during the trading day, while mutual funds are traded only at the end-of-day price. That means you can quickly react to news.
Fancy strategies. With a stock, you can short the market, or bet that the price will fall. You borrow shares from your broker, sell them and hope to buy replacements later at a lower price. You can’t short a standard mutual fund.
With stocks, you can also place short-term bets and play with options, which are the right to buy or sell a block of shares at a guaranteed price for a given period.
But sophisticated strategies and day-trading are not wise for individual investors, says Nicole Boyson, associate professor of finance at the D’Amore-McKim School of Business at Northeastern University. “Day trading is a bad idea for everyone. It’s costly in terms of both trading costs and taxes, and it has nothing to do with fundamental research,” she says.
[See: 11 Great Investing Tips for Women.]
Taxes. “One of the advantages of owning individual stocks is the extra flexibility you have from a tax standpoint,” Tharp says. “Whereas a mutual fund will generate capital gains that are distributed [and taxed each year] regardless of whether an investor sells their mutual fund position, an investor holding individual stocks is in greater control of the timing and magnitude of capital gains realizations.”
Dividends. With a fund, you’ll be lucky to get a dividend yield of 3 or 4 percent. But some individual stocks pay more. That’s nice for income-oriented investors. “Dividend-payers can make sense to own individually if you are trying to target a certain yield percentage on your portfolio,” Robertson says.
Others caution against fixating on dividends.
“The thing is that dividends represent a trade-off,” McGuinness says. “Companies that are paying a high dividend are doing so because they are bringing in cash, but significant growth prospects aren’t there. You receive the dividend, but it means that the company is going to grow more slowly — so the price will grow more slowly.”
Investing in individual stocks, Robertson says, requires some clear thinking and study.
“If shopping by yourself, you should have a well-established investment philosophy,” he says. “Are you a value investor? Do you like trend-following strategies? Are you looking for dividend income? Don’t just buy something because you hear a ticker on CNBC and see the price is up 30 percent in the last year.”
Of course, funds have advantages, too.
Professional management. For your modest fund fee, you’ll get professional analysts and stock pickers for the heavy lifting. It’s far cheaper than paying a broker or financial advisor to recommend individual stocks.
“If you are not an expert, you should not pick individual stocks, in my opinion,” Boyson says.
She feels individual investors do better with funds and ETFs than hiring an advisor to pick stocks, since few pros are able to beat the market consistently. But a pro using funds and ETFs can help one develop a long-term strategy, prepare an estate plan and do other chores that take expertise, she says.
Diversification. One or two funds is enough to spread your risk, while you might need dozens of individual stocks to assure that some bad choices don’t wipe you out.
Tax efficiency. Many mutual funds — index funds in particular — are especially kind at tax time, even though they do not offer the fine control over tax matters that stocks can provide. With a basket of stocks, you or your pricy pro must decide when to sell winners and losers to get the best mix of realized gains and minimal taxes.
Having it both ways. One way to tackle the stocks-versus-funds dilemma is to take the middle ground, with ETFs. They are listed like stocks, can be traded throughout the day, have options and can be shorted, while offering many benefits of funds like easy diversification and tax efficiency.
[See: 8 Soaring Stocks That Suffered the Big Bounce.]
Or you can do both: use funds and ETFs for the core of your portfolio and dabble in individual stocks on the side — but only with money you can afford to lose.
More from U.S. News
9 Ways to Harness the Growth of Latin America
The 9 Best Investors of All Time
An Investor’s Guide to Choosing Stocks and Bonds originally appeared on usnews.com
