Finance vs Feelings: Investing in Individual Stocks

by Kevin on September 13, 2012

This is the third post in a series to contrast spending, saving, and investing your money with your head vs your heart. I hope you’ll join me in the conversation. 

I know what the right answer is.

You know it, too, if you’ve ever read a quality personal finance blog.

The answer is flat out: no. Not worth your time. Do more productive things with your time. You’ve read the reports from major media outlets. You know the gist.

Still, we are drawn in. It is so tempting.

Profit.

Charts.

“Pro” features.

If the answer is no, what is the question?

“Is it a good idea to invest in individual stocks?”

Should I Invest in Individual Stocks?

The idea of trading or investing in individual stocks is so alluring. There is an entire industry dedicated to making you feel like the biggest, baddest, most experienced stock trader on the planet. (That industry is, of course, online brokerages.)

Yet historical data shows us that for the average investor, individual stocks are a crapshoot. Your odds of seeing success are tied more to dumb luck than to any amount of investing skill you have. And if you see successes your brain is far more likely to encourage you to continue throwing money in because you’re winning and you think you’re a savvy investor. Reality hits when your picks go down. Savvy investor title out the window, dumb luck enters in.

I know better. I’ve read reports in Money magazine and elsewhere. I know that picking individual stocks is likely to turn out lesser returns than just sticking the money into a mutual fund or ETF. The head says “do these simple things, set your investments on autopilot, and get back to work.”

Yet the allure is still there. And it probably doesn’t help that I’ve reading Benjamin Graham’s The Intelligent Investor, which is essentially both a warning and a how-to for picking value stocks. (Yes that is a massive generalization of a very thick book.) The heart says “But we can do better! It won’t take that long! Look at this new system I came up with to pick stocks!”

Picking Individual Stocks is a Lot of Intense Work

One thing Graham deserves credit for as he discusses his methodologies for identifying good value stocks is a warning to his readers: researching, monitoring, and investing in individual stocks is a time consuming venture.

Yes, there are profits to be made. (Benjamin Graham literally taught Warren Buffett everything that made him a billionaire.)

But know that those profits are made with an intense scrutiny of stocks with a deep understanding of their businesses added with a dash of extreme patience.

In short, your average investor that thinks he can beat the market by randomly selecting 10 stocks is kidding himself. There are teams of analysts in major financial cities around the world that manage trillions of dollars in investments. Those analysts and their managers are paid handsomely to spend 50 to 80+ hours per week sifting through financial reports and data to come up with a fair value for a stock. Entire teams of people working around the clock to identify stocks whose prices are well below their fair values.

Oh, and here’s the kicker: many times those well paid teams underperform the market. In short, there are teams of people that get paid to manage investments for living — that do this day in and day out — who still get stock valuations wrong.

And yet average investor — like me! — thinks he can spend a few hours per week looking over some reports to pick the best of the best and come out on top.

This is the crux of Finance vs Feelings for me. I know in my head that putting a portfolio on autopilot is the wisest financial decision. But my heart dreams of the riches we could have buy picking the right stocks and outperforming those teams of financial analysts. My heart also likes the challenge of doing a proper analysis and helps encourage my emotions along with thoughts of “just think how smart you’ll feel when your stock pick works out just like you expected”.

The only problem is: I haven’t made that stock pick. Yet the emotions are there already in your head, encouraging you on.

It’s a slippery slope. Many writers have come to the conclusion that people are still going to want to invest in individual stocks. Instead of barring them from ever participating — and then watching as readers plunge their entire 401k into the abyss — it is often given as an idea to set aside perhaps 5 or 10% of your investment money to this purpose. In all likelihood you underperform the market or lose everything. If so, the financial loss won’t crush you because you didn’t put all your chips into the pot.

Have you ever wanted to sell all your mutual funds and invest in individual stocks?

{ 1 comment }

Aaron Hung September 16, 2012 at 1:31 pm

Do you think the same goes to picking dividend stocks? I think the only way to pick the right stock is if you know any inside information. That’s what separate us from the rich

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