These days more and more investors are turning to low-cost exchange-traded funds. It begs the question: Is it worth taking the time to build an individual stock portfolio? If you’re willing to put in some time and research, there are advantages to individual stock ownership.
While ETFs and mutual funds make it easy to build a diversified portfolio and participate in the overall market, Ayako Yoshioka, senior portfolio manager at Wealth Enhancement Group, says if you want to express your own views on security selection or sector weights, building your own stock portfolio is the way to go.
How can you start building your own stock portfolio? Use these tips as a guide and take it step by step:
— Carve out some study time.
— Know your goal.
— Have an exit strategy.
— Keep taxes in mind.
— Keep your options open.
Carve Out Some Study Time
Building a solid stock portfolio is going to require some time, research and homework. Unlike mutual funds and ETFs, you won’t have a professional money manager choosing which stocks to buy and monitoring when it’s time to sell.
Luckily there are plenty of free education resources available online. You can use journalism resources like this article to get you started and help you along the way. There are also analyst reports, like those published by Morningstar, that can help you delve into the merits and risks of specific companies.
Books can also be great resources for more traditional learning. Judi Leahy, senior wealth advisor at U.S. Consumer Wealth Management, says everyone should read “Stocks for the Long Run,” by Wharton finance professor Jeremy Siegel.
A key difference between passive investing through funds and building your own stock portfolio is that you can’t afford to ignore the news in the latter. If the media is talking about a company you own, you’d better be paying attention because that news could have a big impact on the stock’s current and future price. By the same token, buying solid companies for the long run is a preferred strategy of many investors, and you don’t want to sell just because one of your picks is getting some temporary bad press.
So as you can see, stock portfolios require a lot more day-to-day diligence than fund portfolios. So while the access to market information is greater than ever today, the price of building a stock portfolio largely consists of one factor: time.
Know Your Goal
Before you can start choosing stocks for your portfolio, you need to know your goal for these investments, Yoshioka says. Are you looking for capital appreciation and growth through share price increases? Do you want income from dividends?
“History tells us that the stock market gives strong returns,” Leahy says. “Over the last few years, we have seen tremendous growth in the equity markets, particularly in the growth sector. I believe everyone should have some growth component in their portfolio.”
Your goal will dictate which types of companies you should add to your portfolio and in what proportion.
[ READ: How to Invest in Stocks for Beginners ]
Your portfolio should be well diversified with holdings across multiple sectors and geographies, Yoshioka says. “It has been shown academically and mathematically that an investor obtains effective diversification by holding as few as 40 stocks.”
That said, remember that diversification is not about how many investments you own, but rather owning investments that serve different roles in a portfolio. A portfolio of 20 U.S. blue-chip stocks is less diversified than one with only three stocks that cover U.S. large-cap, U.S. small-cap and international stocks.
The amount of stocks that’s right for your portfolio will depend on the asset level, risk tolerance and time horizon, Leahy says.
“There is such a thing as being too diversified,” she adds. She doesn’t believe there is an actual number of stocks you should own. Instead, focus on filling in the style boxes, including large-, mid- and small-cap, and growth and value.
Have an Exit Strategy
It may seem counterintuitive to be talking about selling your positions when you haven’t even built the portfolio yet, but having an exit strategy is essential to successful investing.
“Money managers have a strict mandate around when and why to sell a stock,” Leahy says. The criterion could be that the stock reached its target price, or the company missed its earnings estimate or had a change of management, for example.
Having an exit strategy can also help you avoid panic selling or getting emotionally attached to a stock.
“It is easier to know what to buy than it is to know when to sell,” Leahy says. So invest some time into your exit triggers before you commit to any stock purchase.
[ READ: How to Build an Investment Portfolio ]
Keep Taxes in Mind
“Lastly, the tax status of the account that holds the stock portfolio should be considered, as it will have tax implications when trades are implemented,” Yoshioka says.
The IRS taxes capital gains and dividends earned on stocks unless they’re held in tax-deferred accounts, such as an individual retirement account, or IRA. Taxes can be a particular pain if you only hold the stock for one year or less. After the one-year mark, you’ll qualify for lower long-term capital gains rates.
An upside to managing your own stock portfolio is that you control when you take your capital gains. You won’t get hit with an unanticipated year-end distribution, as with mutual funds. You can also choose to sell investments at a loss to take advantage of tax-loss harvesting. Just watch out for wash sale rules, which disallow losses on investments you sell and then replace with a similar holding within 30 days before or after the sale.
Keep Your Options Open
While anyone can build a stock portfolio with enough time and research, stock portfolios are not right for everyone.
“Investors who have the time and passion to research individual stocks and companies may benefit more than those who do not have any interest in the work needed to build and maintain a portfolio of individual stocks,” Yoshioka says.
If you don’t want to put in the time to monitor each individual stock, ETFs could be a better option.
“ETFs provide an efficient way for investors to seek broad exposure to large baskets of stocks, with the potential to minimize the risk of any one company falling on hard times,” says Jeff Weniger, head of equity strategy at WisdomTree. “Another great benefit of ETFs is their transparency. When an ETF tracks an index, investors who wish to see all the holdings can do so by going to an issuer’s website.”
Of course, Weniger also believes stock portfolios are “generally appropriate for almost everyone.”
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Update 08/12/22: This story was published at an earlier date and has been updated with new information.