You can be a successful investor without picking individual stocks for your portfolio. But if you think you have what it takes to be a first-class stock picker, you really owe it to yourself to give it a try. And if you're worried about the risk, there's an easy way to get started without putting your entire life savings in jeopardy.
Why so many skip stocks
There's a wide variety of reasons why people never invest directly in stocks of particular companies. On one hand, some investors are completely uncomfortable with the risk of owning stocks in any form. Especially among those older investors who still remember firsthand the Great Depression and its aftermath -- memories that seemed all too familiar during last year's bear market -- the reluctance to put their money at risk is understandable.
On the other hand, many investors get exposure to the stock market indirectly through owning investment vehicles like mutual funds and ETFs. Although they may never buy an individual stock, these investors get most of the benefits of a diversified stock portfolio in a simple and convenient package.
What you're missing
If there's no place for stocks of any kind in your investing strategy, then clearly, individual stocks won't interest you. But for most of us, stocks make sense as a way of building wealth. You therefore need some way of getting stock exposure in your portfolio. And if you need stocks, here are some good advantages that individual stocks have over funds and ETFs:
- Precise focus. Being able to focus your investing dollars on a single company concentrates your investment as precisely as you want, letting you benefit from your best ideas without having your returns watered down by also-rans.
- Experience. Investing with funds is mostly hands-off. With stocks, on the other hand, you get a chance to dig deep into company financials. Along the way, you learn a lot about investing and the business world in general.
- Lower cost. With most discount brokerage accounts, the only cost you'll pay to own an individual stock is the commission when you purchase it. In contrast, mutual funds and ETFs keep charging you management fees year in and year out -- fees that can add up to thousands of dollars over the course of your investing lifetime.
Big returns. No matter how well a fund does over the long haul, it will never be able to match the capital appreciation of the top stocks. Guess?
(NYSE:GES), Netflix (NASDAQ:NFLX), and Nuance Communications (NASDAQ:NUAN)are just a few of the stocks that have averaged 30% plus annual returns over the past five years -- you won't find a diversified stock fund that's matched that record.
If buying individual stocks still terrifies you, though, there's an easy way to get started. Even if things go terribly wrong, you can rest assured that you'll emerge relatively unscathed.
Stick to the core
The basic idea is simple: if you already own a strong core portfolio of stock mutual funds and ETFs, then hang onto them. But instead of directing your new investments into more shares of those funds, funnel it into a brokerage account instead and slowly work your brokerage assets up until they reach a small but respectable fraction of your total holdings: perhaps 5% or 10% for starters.
That approach mimics what many investors call their "play" accounts. They may invest the bulk of their money using an asset allocation strategy that splits their money among big-name blue chips like IBM
But with a small amount of your money, you can take risks you wouldn't otherwise feel comfortable with. For instance, if you think cloud computing is the wave of the future, you can buy some shares of a company like salesforce.com
Take the plunge
You don't absolutely need individual stocks in order to be a successful investor. But if you devote even a small amount of your portfolio toward experimenting with stock picking, you'll likely find that it's worth the effort you put in -- both by giving you a broader investing experience as well as improving your returns.
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Fool contributor Dan Caplinger bought his first stock more than 10 years ago and hasn't looked back. He doesn't own shares of the companies mentioned in this article. salesforce.com is a Motley Fool Rule Breakers selection. Netflix is a Motley Fool Stock Advisor pick. Petroleo Brasileiro is a Motley Fool Income Investor recommendation. Nuance Communications is a Motley Fool Hidden Gems pick. Try any of our Foolish newsletters today, free for 30 days. There's nothing risky about The Fool's disclosure policy.