I’ve seen this before. Twice, now that I think about it. Once in college, and again in 2007. It is so easy to talk yourself into and seems like such a good idea at the time.
I’m talking about buying stocks, although I could just as easily be referring to toga parties. They both look like fun on paper, but eventually, the reality of your situation hits you, and you wish there were no evidence that you ever participated.
I was in college during the tech boom of ’99 and managed to scrape together $2,000 from my summer of working construction to get in on the action taking place in the stock market. Every day I would watch the news and see the market do nothing but hit record highs. I followed a number of companies, and every day they all seemed to do nothing but go straight up.
Eventually, I had to get in the game and opened a brokerage account. I invested alongside my dad in a company called Lucent Technologies. After all, I was studying Management Information Systems at a regional university; clearly, my technology expertise would allow me to master this sector of the stock market.
Over the next couple of months, I watched Lucent slowly gain steam and my $2,000 turned into $2,100, then $2,250, and eventually $2,400.
My brilliance was just getting started, however. One day I awoke to phone call from my dad (why he thought a college student would be awake at 10:00 am is beyond me), who asked how much good news I could handle that day. Lucent had released a piece of crazy, exciting news, and my investment had jumped to over $8,000!
Yes!! It was as easy as everyone said. That would be enough to pay for a full year of school, or a summer of not working, preferably. I have always been a patient person, and I decided not to sell right away. I would "invest for the long-term," as if I had any idea what that meant at the time.
You can probably suspect where this story is going, so let me jump to the end. I was so patient and disciplined (at least in my mind), that I rode that investment all the way back down to $3,000 before I finally sold it. I made a profit, but it was nothing but a soul-crushing defeat. The problem with buying stocks is that you have to know when to get in, and know when to get out. And then you have to know that for everything single investment you own.
From my perspective, that is a lot of work. All that time for something that, statistically speaking, you have zero chance of ever being even average.
I completely understand why people are more likely to talk about buying individual stocks instead of a boring index or mutual funds. If you are out on the town for the evening, which is more likely to make you the envy of your friends?
* Have you heard about that company PharrowTech that just had a major breakthrough in the retractable syringe market? I checked out their stock the other day, and it looks like it’s about to explode! I picked up a bunch at $8 a share, and the analysts think it’s going to $78 by the end of the year!
* The S&P 500 has been a great investment. I continue to get the average return of 500 huge companies, and I haven’t even heard of 487 of them!
Fancy doesn’t mean better. Over time, virtually everyone will be better off with the more boring version. Luckily, I convinced my wife of this philosophy many years ago.
You may also hear that people like the tax advantages associated with owning individual stocks. This strategy is far more tax efficient than traditional mutual funds. The truth is, however, you can obtain the same tax advantage by owning Exchange Traded Funds (a very inexpensive type of mutual fund).
Another reason to avoid buying individual stocks versus index funds is the transaction costs associated with trading so many positions. Prices to trade stocks have come down to $5, or less in many circumstances, but eventually you pay for those transactions. We (and you) can purchase well-diversified mutual funds and not incur transactions costs, making them more efficient to own.
When seemingly every stock goes up almost every day, it can be easy to think this is the time to get in on the action. Why can’t I be a stock picker? I know a lot about my iPhone; why can’t I buy Apple stock directly? My feet hurt; I wonder if Dr. Scholl’s is a publicly traded company?
I will save you the math, but here is the reason not to buy individual stocks: To receive an average return, why would you take on more than average risk? I realize that there are a lot of companies that make for intriguing stories, whose stocks seem to go up forever. The temptation can be extreme, just like a toga party.
I have seen the ending to this movie twice before, and there is only one way to protect yourself. Own companies that specialize in producing profits, not press releases. Stay diversified, stay patient, and stay away from technology companies you don’t understand, no matter how many 200 level classes you have had on related subjects.